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By Beverly DeVeny, IRA Technical ExpertThis scenario happens all too often. This particular story ended up in tax court where the IRA beneficiary lost his case. (Morris, et ux. v. Commissioner, TC Memo 2015-82).
George owned an IRA. He named only one child, Elroy, as the beneficiary of the IRA. Elroy was also the executor of George’s estate. George then died.
Elroy consulted with a law firm and worked with a paralegal on the settlement of his father’s estate. He was told that there would be no “tax” on a distribution from the IRA. He took this to mean no income tax as well as no state or federal estate taxes on a distribution from the IRA.
Elroy took a total distribution of the IRA. He then issued checks to his two siblings for a portion of the distribution in accordance with what he believed would have been his father’s wishes. He did not include the IRA distribution on his federal income tax return.
The IRS sent Elroy notification of the taxes due. Elroy felt that he should not be liable for all of the income tax on the distribution since he had shared the funds with his siblings and he had received erroneous advice from the law firm.
The Tax Court, although sympathetic to Elroy, had no choice but to rule against him. The tax code is very clear that distributions from inherited retirement plans, such as IRAs, are taxable to the beneficiary who is named on the beneficiary form.
Since George only named Elroy on the form, the inherited IRA distribution went to Elroy and will be taxable to Elroy. It makes no difference that he shared the distribution with his siblings.
Don’t make this mistake. If the IRA should be shared by all siblings, then make sure that all siblings are named on the beneficiary form. Also be sure that each sibling’s share is clearly stated on the form. If they are to inherit equally, be sure that the form reflects that. If they are inheriting by percentages, make sure that the percentages add up to 100%. When this is not done correctly, bad things happen to people like Elroy.