Leaving an individual retirement account to an estate is not a great idea. For one thing, it subjects the IRA to costly and time-consuming probate proceedings that could have been avoided by the naming of a non-estate beneficiary. In probate court, the assets in the IRA are fair game to creditors, and the trustee might have to distribute the IRA immediately, creating a tax bill. The estate must report any distributions from an IRA on Form 1041.
According to IRS guidelines, any distributions that an estate initiates from an IRA must be report on Form 1041. Failure to do so could result in fines and / or other penalties.
Using Form 1041 for Estates
Internal Revenue Service Form 1041 is the income tax return for estates. The executor must file Form 1041 each year an estate earns income until all the assets are distributed to beneficiaries. The form uses the same general rules for reporting income and deductions as those governing individual returns. The executor must report as income any distributions from an estate's inherited traditional IRA.
If the probate court determines you to be the ultimate beneficiary of the IRA, the executor will transfer the assets to an IRA set up to receive the inheritance. The transfer is a non-taxable rollover and is not reported on Form 1041.
Income Distribution Deduction
Form 1041 will come into play if the estate withdraws money from an IRA. If the estate then distributes the money to you as the ultimate beneficiary, you must report any taxable income on your individual tax return. Using Form 1041, the estate executor also reports the distribution as income, but deducts the amount on Schedule B of the form.
A distribution from a Roth IRA is normally tax-free, and the executor doesn't include it in income or deduct it on Form 1041. However, the executor must still file Form 1041 for Roth distributions, because the form’s “Other Information” section reports tax-exempt income.
Receiving the IRA
A spouse can roll the inherited IRA into her own. By doing so, she doesn't need to take distributions from a traditional IRA until she reaches age 70 1/2. She need never distribute money from an inherited Roth IRA. A non-spouse beneficiary sets up a “beneficiary IRA” in the name of the deceased for the benefit of the beneficiary. A beneficiary IRA has special rules. You can’t roll money in or out after the initial rollover, and you can’t contribute to a beneficiary IRA.
You must take distributions according to IRS rules, which might require that you empty the account within five years. As with all traditional IRAs, you only pay income taxes when you withdraw money from a traditional beneficiary IRA. You can also set up a beneficiary Roth IRA, but unless the deceased left behind a Roth IRA, you must pay taxes on the entire rollover amount when you receive it.
Distribute Quickly to Minimize Estate Tax Liability
The tax laws motivate the executor to distribute an estate as quickly as possible, because estate income tax is brutally high. In 2017 and 2018, you'll pay a base amount of tax based on the value of the estate plus a rate on the excess in one of 12 tax brackets ranging from 18 percent to 40 percent. Any traditional IRA distributions to the estate are subject to these rates.
Had the deceased named an individual as the traditional IRA beneficiary, the lower personal income tax rates would apply to any distributions. The IRS includes the value of traditional and Roth IRAs when figuring estate tax. An executor of an estate subject to these taxes might have to liquidate an IRA to help pay estate taxes. If so, the executor must report it on Form 1041.
- Stockbyte/Stockbyte/Getty Images