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You are correct. Had you used the Pub 559 formula from the start, you would have larger estate tax deductions each year, but more of that deduction would have offset your taxable income in lower brackets. A lower annual deduction is less likely to be applied to these lower brackets. Therefore, perhaps you just stay with your current method for consistency, even though it generates a lower deduction (and will therefore last more years) than the correct method in Pub 559.
Re your last paragraph – yes you definitely cannot increase the total IRD above the amount you inherited, because that figure is limited by the estate tax return of the decedent. However, the FIFO theory is that the first dollars distributed from your inherited IRA do not have to be apportioned in some manner between subsequent investment gains and the original IRD amount, so you can treat your distribution as all IRD until the entire amount of IRD is applied to generate an estate tax deduction. This will accelerate the distribution of the IRD and in turn accelerate the estate tax deduction, but it will not increase the total amount of IRD or estate tax deduction available. Again, any apportionment or FIFO decision is based on the opinion of tax experts since no specific IRS guidance on these issues has been issued.
Nor has there been direct guidance on QCD adjustments to the formula. Note that reducing the amount distributed by the QCD would have the same effect as if you inherited an IRA with basis from non deductible contributions (Form 8606 would be used to report the distribution), any IRA basis would be inherited by you. Conversely, a QCD is applied solely by you to reduce the taxable amount distributed. Not clear if the IRS would perceive some distinction between the QCD and inherited basis.
Yes, I grabbed IRD amount instead of the actual estate tax of 381,000, so you would still receive your total deduction by the time the IRA was drained the way you have been doing it. However, you could have deducted the estate tax at a faster rate by using the Pub 559 formula and the 2019 deduction would be nearly 100,000 using that formula.
Since the method you have been using has never been questioned, you could be consistent and maintain that to the last year. If you report a drastically increased deduction for this year in proportion to your 1099R, it might trigger an inquiry. So could any amended returns you file for 2016-2018. However, now that it appears you would complete your deduction in about 3 years without losing any of the total deduction of 381,000, it may be better to stick with the method you have been using which still generates the correct total deduction, just at a much slower annual rate than you could have received it by using the Pub 559 formula.
Yes, it appears that your calculation understates the IRD deduction you have been entitled to for each year. Kitces’ FIFO method means that gains in the IRA that result in a larger distribution can still be treated as IRD, but only until the full IRD deduction has been recovered, which you actually might have fully recovered by now. With only a 23,228 annual IRD deduction, by the time the IRA is drained (another 3 years) you will only have recovered about half of the total deduction.
Therefore, if you continue as is you will end up losing half the deduction. If you change methods now (or decide to amend 2016-2018) there is a chance the IRS could disallow the additional deduction you should have claimed for the first 12 years instead of allowing you to carry it forward. However, I would discount that possibility and amend those returns for a sizeable refund. The deduction will vary somewhat each year relative to the gross amount you distributed.
Therefore, in very rough numbers if you recovered 23,000 for 12 years, that is around 276,000. For 2016-2019 if you average 95,000 per year that would bring your total to 656,000 recovered through 2019. The remaining amount of 220,000 (876,000-656,000) would nearly be fully recovered in 2020 and 2021.
NOTE: I am assuming that the 381,000 “original estate tax deduction” (the one time determination) is correct. That figure should be the difference between the estate tax actually paid by the decedent less the estate tax the decedent WOULD HAVE paid had the inherited IRA not been included in the estate tax calculation. So this figure should be the estate tax attributed to your inherited IRA. I would be sure that figure is correct since it is the amount multiplied by the fraction each year since you started.
It is fortunate that misc deductions NOT subject to the 2% AGI floor like the IRD deduction are still available.
Obviously, recovery of your full IRD deduction over the remaining 3 years is a much larger issue than the minor affect of a small QCD. You probably should still NOT include the QCD amount in the 2019 calculation of your IRD Deduction. And of course for 2019 you would need to correctly report the QCD on line 4a and 4b to eliminate it from taxable income. The 1099R will include the QCD, so you need to subtract it on line 4.
Yes, example 2. That example illustrates where a beneficiary received 12,000 in a year out of a total of 20,000 he had a right to receive. That fraction is multiplied by the amount of the decedent’s estate tax paid allocated to the amount the beneficiary inherited. The 4620 and the 20,000 figure was determined one time and remains fixed.
Applied to your situation, the amount you distribute in a year (RMD or otherwise) will probably vary, so your IRD deduction would vary from year to year until it was fully claimed. However, the QCD amount will not be included in your income, so the amount you received should be reduced by the QCD amount. Say you inherited 1,000,000 of (taxable) IRD, and this year you are withdrawing 100,000 including a 4400 QCD. You would then claim an IRD deduction of 95,600/1,000,000 times the estate tax that the decedent paid on your share of the amount you inherited.
Here is an article by Michael Kitces explaining the IRD deduction on an inherited IRA. https://www.kitces.com/blog/understanding-the-irc-section-691c-income-in-respect-of-a-decedent-ird-deduction-for-the-beneficiary-of-an-inherited-ira/
See example 3 in the above article. Also, note that the IRS has not issued specific guidance on the handling of gains, and that also applies to QCDs, where you are actually receiving income the decedent would have been taxed on, but you are allowed to use a QCD to escape that tax. So it makes sense not to claim the IRD deduction on the amount you withdraw this year that was distributed as a QCD.
Yes, since a QCD is not included in gross income, the IRD deduction cannot be taken for QCD amounts and this operates in the same manner as if the inherited IRA included basis or was an inherited Roth IRA. Of course, this is moot unless you still itemize given the new higher standard deduction.
As for the math, it would be more direct to figure the IRD deduction by just reducing the gross distribution by the amount of the QCD and plugging that figure into the formula outlined in Pub 559. I’m not sure whether that would generate a different figure than your proposed 4.4% reduction or not. Of course, once you have recovered the full IRD deduction, the deduction ends even if value remains in the inherited IRA.
It is interesting to note how the QCD adjustment with respect to the deduction differs from NOT doing a QCD, being taxed on the distribution and then making an itemized taxable donation. The latter method would not reduce the IRD deduction, while the QCD would. The reduction of the distribution by the QCD amount is the same as if there was inherited basis in the IRA except that the QCD is triggered by you, while the basis was contributed by the decedent.
Here is an interesting article from Kitces regarding the IRD deduction and in the middle of it he touches on inherited IRA RMDs and the effects of gains or losses on the IRD Deduction.
- This reply was modified 1 week ago by Alan S..
First paragraph – Yes, except that in the year he would have reached 70.5, she would only be about 56. If she assumed ownership that year, there would be no RMDs for her because she is treated as the owner the entire year. But by owning the IRA at 56, any distributions she would take prior to 59.5 would be subject to the 10% penalty. Therefore, the choice boils down to the need for distributions for 3 plus years. If she will need them best to take the small beneficiary RMDs penalty free. If does not need them and prefers to avoid RMDs that are not needed, then she could assume ownership. This can also be done partially, ie do a spousal rollover for part she will own and leave the rest as inherited until 59.5.
Paragraph 2 – interesting. If the early RMD years will have RMDs cut by 5-6%, those higher balances will start to erode the advantage of the new divisors. There will also be larger distributions after the first spouse has passed that will be taxable to single filers.November 17, 2019 at 6:21 pm in reply to: parent with taxable Betterment – need tax returns? #4925
Perhaps an accountant who specializes in “Offers in Compromise” to the IRS would also be able to assess the exposure to those who received gifts of the taxpayer’s assets when it is evident that the purpose of the gifts is to avoid back taxes and penalties. Most likely, if the tax bill is small enough, the IRS would not bother to pursue this, but if the tax bill is small, the taxpayer would be better off determining the amount of back taxes and penalties likely to be levied.
1) You are correct. If sole beneficiary spouse takes distributions in years before deceased spouse would have reached 70.5, these are not RMDs, just distributions. Correct that these distributions have no minimum or maximum limit.
2) Correct. With second option starting when deceased spouse would have reached 70.5 (12/31 of that year), there is the RMD minimum but no maximum distribution. All distributions from the inherited IRA are coded 4 on the 1099R and therefore have no 10% penalty regardless of age.
3) The beneficiary’s recalculated age (enter Table I each year) is used in this case. The decedent’s non recalculated age would only apply if they passed after the RBD and was younger than the beneficiary spouse. This would produce a lower distribution and therefore would be the RMD as long as it remained lower.
4) Yes, the surviving spouse can do the spousal rollover (best done by electing to assume ownership) anytime they wish, but this is an irreversible decision. In any year AFTER the year of owner’s death, if a spousal rollover is done, the RMD for that entire year is calculated from the Uniform table, making the RMD for that year much lower than a beneficiary Table I RMD. A beneficiary RMD does not have to be done first and in fact the election of ownership is best done prior to taking a distribution for that year. If a beneficiary distribution (Code 4) is taken PRIOR to assuming ownership and exceeds the Uniform Table RMD, the amount in excess of the Uniform table RMD can be rolled back if done within 60 days, to reduce the distribution to the Uniform table amount. While an RMD cannot be rolled over, the act of assuming ownership effectively recalculates the RMD for that year to the lower amount. But to avoid this confusion and using up the one rollover allowed, it is preferable to not take any distribution in the year of ownership election until after the IRA is owned. That avoids the code 4 1099R.
I think we have discussed before another way to accomplish the spousal rollover, and that is failing to take the full beneficiary RMD in an RMD year. That IRA then defaults to ownership status, effectively reducing the RMD for that year. But this should also be avoided if possible because it leaves the IRA titled differently than it’s ownership status and also causes confusion.
In summary, there are various ways to do the “spousal rollover”, but the best is to elect ownership first to avoid a 1099R with a code 4 and also avoid using up the one 60 day rollover permitted. At the time of the election, the custodian will usually transfer the balance to an owned IRA. Then the Uniform table RMD can be taken by the end of the year if the beneficiary has reached 70.5. Most spousal beneficiaries will elect ownership after 59.5 and not wait until the deceased spouse would have been 70.5.
It is interesting that an IRS study released this week in conjunction with the recommendation of new RMD tables starting in 2021 found that only 20% of IRA owners limited their distributions to the RMD amount after 70.5. That means that 80% take out more than their RMD, so the reduced RMDs from the new tables (down 5.5-6%) will not help 80% of older IRA owners. It will only help the 20% with higher incomes that for which only the RMD is enough.
You will receive a 1099R reporting the gross distributions for 2019. If you have reached 59.5 at the time of your distribution, your Roth will be fully qualified and tax free and you will not have to file Form 8606. You will just enter the gross distribution on line 4a of Form 1040. This is very simple.
However, if you are under 59.5 you will have to file Form 8606 to report your distribution and will have to know your regular contribution basis and your conversion basis to complete the form. Your regular contributions comes out first, then your conversions come out in the order you made them. As long as you do not withdraw more than all these contributions, your distribution will be non taxable since any earnings come out last and you will only have a taxable amount if you reach your earnings. If you reach your earnings you will also owe a 10% penalty on the earnings amount.
So much easier if you are 59.5 because you will not have to determine the amount of all your past contributions and conversions. If you have not been tracking those amounts and are under 59.5, this could amount to a challenging research project.
Kaneohe, this should meet the IRS definition of a direct transfer since the IRA owner cannot cash the check.
However, from a practical standpoint, it appears that most custodians place a number of restrictions on IRA check writing including a firm statement that they will issue a 1099R on all checks. That increases the chance of a 1099R/5498 mismatch. Some restrict the checks to those over 59.5, or do not allow check writing on inherited IRAs or Roth IRAs. Withholding is handled differently with one firm requiring it be declined and another stating they will withhold the 10% by a separate distribution unless it has been declined. Some will not allow the IRA to be closed with an owner check.
Therefore, it’s necessary to carefully review any agreement you sign with your custodian regarding check writing, since these are not standard and there could be unanticipated restrictions included.
It appears that one of you is 55 and the other 50-54 from the HSA limits you posted. Box 1 of your W-2 should be 18,700 unless there are other pre tax deductions (FSA, pre tax health premiums, etc. That leaves room to max out your Roth IRA contributions @ 7000 each including spousal contribution, and add 7000 to your HSA contributions to max out the HSA at 8000.
Since Roth 401k contributions do not reduce your W-2 Box 1 amount, you could have contributed much more to the Roth 401k without affecting your taxable comp eligible for Roth IRA contributions. As such, when making Roth 401k contributions, you can use the same income for making either Roth IRA or TIRA contributions.
You might consider that if the current gains are significant enough. As JTs, there is a step up on 50% of the assets. Should you pass first (and the gifting of her share to you was completed more than 1 year before your death, there would be a full step up at your death. On the other hand, should she pre decease you, this backfires and there is no basis adjustment at all upon her death.
These rules apply per asset, not per account. Therefore, if you proceeded you would leave any assets with little gain or with losses in the joint account. If the basis adjustment is a “step down”, better 50% than 100%.
Hi, Tom. You are correct. But the last paragraph below poses an interesting question.
If the surviving spouse inherits a “qualified joint interest”, their basis is the original cost basis of half the property and the DOD cost basis of the other half (the half they inherited). It does not matter which spouse made the purchases. If the account was community property in a community property state, the entire value receives the basis adjustment.
In many brokerages, the couple could name a TOD beneficiary while both living, that would allow transfer to that beneficiary upon the second death or common disaster. However, VG inexplicably will NOT accept such a TOD on a joint account. Therefore, the surviving spouse should quickly name their own beneficiary on the account at the same time the account is retitled in that spouse’s name.
One issue that all the IRS Pubs gloss over is holding period. Of course, inherited assets always have a LT holding period, but what the Pubs do not confirm is the holding period for the survivor’s interest in qualified joint property that was purchased just before the death of the first spouse. The surviving spouse’s share that was owned all along does not get a basis adjustment, but does it get a holding period adjustment to LT or does it actually have to be held 1 year before it gets LT treatment? Most likely tax preparers routinely report all such sales by the surviving spouse as LT, but I do not know if that is technically correct for this example?
Anyone have cite on this?
This is a restorative payment, and you can either cash it or roll it over to your IRA. Since there was no 12/31/2018 balance in your 403b, this will not be considered as a plan RMD, and is therefore rollover eligible.
However, this has no effect on your IRA RMD, which you will still have to satisfy in its entirety.
OK, so now you no longer have any inherited 401k accounts because both plans have now been rolled into IRAs that you own. The 401k plans have evidently paid out your 2019 beneficiary RMD before the transfers. If these beneficiary RMDs were the same amount that your husband was scheduled to take for 2019, they were probably more than the correct RMD. The IRS will not care about that, they only care if you receive less than the correct RMD.
For 2020, your IRA RMDs will be based on your age at the end of 2020 and calculated using the 12/31/2019 IRA balance. I assume that you do not have a Roth IRA or that your husband did not have a Roth 401k balance. Any Roth IRA you own is not subject to RMDs.