There is confusion about the tax treatment of inherited IRAs. It is true that the inheritance of an IRA is not a taxable event, regardless of the size of the account. An inheritable is tax free. But if the account is a traditional IRA funded by tax-deductible contributions, then distributions become taxable to the beneficiary when and to the extent received.
This is the lesson learned by a surgeon who inherited a sizable IRA from his mother, which she inherited from her spouse (the surgeon’s father). He took a distribution of $360,800 in one year and $148,084 in the next. Both distributions were reported to him on Form 1099-R, but he didn’t include either of them in gross income. He researched inherited IRAs and didn’t think they were taxable. He believed they were a mere reflection of his father’s investments in the account. He tried to obtain documentation from the custodians that had held the account—TD Ameritrade and Fidelity. Neither had the records he wanted. He never told his tax return preparer about the distributions.
The Tax Court said the distributions were taxable (Richard Essner, TC Memo 2020-23). While the court sympathized with his dilemma, he has no legal basis on which to prove his position. What’s more, he was subject to an accuracy-related penalty. While the penalty can be avoided for reasonable cause, the exception did not apply here. Given the size of the distribution and the fact that he never told his tax return preparer about it, the penalty applies. The fact that he tried to research the matter, while genuine, was not sufficient to overcome the penalty.