How many times have you seen advertised that a combination of estate tax and income tax on an inherited IRA could cost the beneficiary as much as 80% in combined tax?
This type of advertising is nothing more than a scare tactic devised to encourage IRA owners and their beneficiaries to seek someone’s advice to solve the tax problem. It is true that an IRA is considered part of the estate and consequently may be subject to estate tax at the death of the IRA owner. It is also true that distributions taken from an inherited IRA are subject to income tax. Simple math would leave you to believe that an inherited IRA would then be subject to both estate and income tax (double taxation).
Most IRA beneficiaries are not aware that IRAs are considered “Income in Respect of a Decedent” (IRD), allowing beneficiaries to take a federal income tax deduction for any estate taxes paid on the inherited IRA’s assets, thus eliminating double taxation. This can be found in Section 691(c) of the IRS Code. Put more simply; any estate tax paid on an inherited IRA will create an equal income tax deduction when funds are withdrawn from the inherited IRA. Don’t get caught up in the sales hype.