What you should do about Estate Tax Deduction and Post-Retirement Tax Treatment of IRA Distributions Part 16

Presented by Paystrubmakr.com      By John Wolf and Tom Cullen CPA

Estate Tax Deduction

Written by Congress, A beneficiary may be able to claim a deduction for estate tax resulting from certain distributions from a traditional IRA. The beneficiary can deduct the estate tax paid on any part of a distribution that is income in respect of a decedent. He or she can take the deduction for the tax year the income is reported. Quoted from the Congress,

Estate Tax IRS

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What’s New – Estate and Gift Tax by  IRS

 Publication 575 (2020), Pension and Annuity Income

Qualified coronavirus distributions. Recent legislation contains special rules that provide for tax-favored withdrawals, repayments, and loans for certain individuals who were impacted by the virus SARS-CoV-2 or coronavirus disease 2019 (referred to collectively in this publication as coronavirus) in 2020. See Coronavirus-related distributions,

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Charitable Distributions from an IRA

If an amount is withdrawn from a traditional individual retirement arrangement, (“IRA”) or a Roth IRA is donated to a charitable organization. Rules that are relating to the tax treatment of withdrawals from IRAs apply to the amount withdrawn, and the charitable contribution is subject to the usually applicable limitations on the deductibility of such quoted contributions. A traditional or Roth IRA owner, age 701⁄2 or over, can directly transfer-tax-free, up to $100,000 per year from all IRAs to an eligible charitable organization (§408(d)(8)). Thus, otherwise, taxable IRA distributions from a traditional or Roth IRA are excluded from gross income to the extent they are qualified charitable distributions(§408(d)(8)). The exclusion may not exceed $100,000 per taxpayer per taxable year. Special rules apply in determining the amount of an IRA distribution that is otherwise taxable. The otherwise applicable laws regarding taxation of IRA distributions and the deduction of charitable contributions continue to apply to distributions from an IRA that are not qualified charitable distributions. Quoted 

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A qualified charitable distribution is taken into account for purposes of the minimum distribution rules applicable to traditional IRAs to the same extent the distribution would have been taken into account under such rules had the distribution not (quoted from de Congress)  be directly distributed under the qualified charitable distribution provision. A qualified distribution must be made directly from the IRA by the trustee to a charitable organization when the taxpayer has attained age 01⁄2. Eligible IRA owners can take advantage of this provision, regardless of whether they itemize their deductions.

Note: Distributions that for contribution from gross income because of the qualified distribution provision for charity are not considered into account in determining the deduction for contribution for charity for under section 170. (Quoted from the Congress) This exclusion was scheduled to expire for taxable years beginning after December 31, 2014. However, the PATH Act reinstated and made permanent the exclusion from gross income for qualified charitable distributions from an IRA.

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Post-Retirement Tax Treatment of IRA Distributions

The cost basis of a participant in an IRA account is almost always zero. Therefore, all distributions are fully taxable as ordinary income in the year in which they are received. The distribution of an annuity contract to a participant is not taxable when received. Instead, when the annuity payments begin, they will be fully taxable as ordinary income. Furthermore, the transfer of a participant’s interest in an IRA plan to their former spouse under a decree of divorce or a written instrument incident to such divorce is not a taxable distribution. After that, the IRA will be treated for tax purposes as being owned by the former spouse.

Distributions from Individual Retirement Accounts and Exceptions

Income In Respect of a Decedent

Distributions to a beneficiary or estate of a deceased individual will be taxed in the same manner as if the participant received them. Life insurance death benefits, however, will not lose their tax-exempt character. Any amounts that are taxable to the beneficiary should be regarded as income in respect of a decedent. Therefore, the beneficiary will be entitled to a deduction from gross income for any federal estate taxes attributable to the inclusion of the IRA in the decedent’s gross estate.

Income In Respect Of A Decedent – IRD

Estate Tax Consequences

The estate tax consequences are nil since the surviving spouse is usually the beneficiary and is entitled to the unlimited marital deduction. However, there were previously some interesting rules in effect which worked to exclude $100,000 of the IRA amount from the gross estate of the decedent. These rules were repealed by TEFRA and, therefore, some estate plans may need reworking to prevent the over-funding of the “by-pass trust.”

Losses on IRA Investments

If a taxpayer has a loss on their traditional IRA investment, they can recognize the loss on their income tax return, but only when all the amounts in all their traditional IRA accounts have been distributed to them and the total distributions are less than their non-recovered basis if any. A basis is the total amount of the nondeductible contributions in the traditional IRAs. The loss is claimed as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income. A similar rule applies to Roth IRAs. The rule applies separately to each kind of IRA. Thus, to report a loss in a Roth IRA, all the Roth IRAs (but not traditional IRAs) have to be liquidated, and to report a loss in a traditional IRA, all the traditional IRAs (but not Roth IRAs) have to be liquidated.

Deducting Losses on Your IRA Investments

Prohibited Transactions

If an individual engages in a prohibited transaction with their account, the account will become disqualified Post Factum for the first day of the calendar year in which the disqualifying event occurs. Where an employer or a union has established a retirement account, and a participant engages in a prohibited transaction, such individual’s account will be treated as a separate account

for disqualification purposes.

The examples of prohibited transactions with a traditional IRA include:

(a) Borrowing money from it,

(b) Selling the property to it,

(c) Receiving unreasonable compensation for managing it,

(d) Using it as security for a loan, and

(e) Buying property for personal use (present or future) with IRA funds.

Effect of Disqualification

If an IRA is disqualified, the participant is taxed as though they received

a complete distribution of the fair market value of the assets in the account. Furthermore, all income accrued in the account after such disqualification will be currently taxable to the recipient.

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Penalties

For each prohibited transaction by a sponsoring employer or union, the law imposes a tax of 15% of the amount involved. Such tax is to be paid by any disqualified person who engages in the prohibited transaction, with the exception of fiduciary acting only in that capacity. If the operation was not corrected within the correction period, then an additional tax equal to 100% of the amount involved is imposed. However, an account will not be disqualified where an employer commits the prohibited transaction. This excise tax of 15% or 100% is not imposed on an individual who engages in a prohibited transaction concerning their account. Prohibited transactions are defined in §4975.

Borrowing on an Annuity Contract

If an owner borrows money against their traditional IRA annuity contract, they must include in their gross income the fair market value of the annuity contract as of the first day of their tax year. They may also have to pay the 10% additional tax on early distributions. 7-57

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