Will I get a 1099-R from an inherited IRA?

When a loved one dies, the named beneficiaries will inherit the assets left behind, including a traditional IRA. If you inherit an IRA from a deceased spouse, parent, sibling, or other relative, you must understand what distribution options are available and the tax implications you face, including the role of the 1099-R form in inherited IRAs.

A 1099-R is a tax form that reports distributions from retirement plans, pension plans, and annuities. If you inherited an IRA, you will receive a 1099-R form from the IRA custodian for each year you take distributions from the retirement account. This tax form shows the total distributions taken from the inherited IRA, which you must report on your annual tax return.

How an inherited IRA works

When an IRA owner dies, the named beneficiaries will inherit the IRA. If you were a named beneficiary, you will be required to open an inherited IRA to continue deferring taxes on the inherited money.

Depending on your relationship with the deceased IRA owner, you may be required to take distributions within 10 years from the date of the original IRA owner's death or take the required minimum distributions (RMD) over your life expectancy. Generally, a surviving spouse has more distribution options than other beneficiaries, and can rollover the inherited IRA into their IRA, and take distributions based on their life expectancy.

Non-spouse beneficiaries can choose to take a lump sum distribution or spread distributions over several years as long as they take full distribution by the 10^th anniversary of the original IRA owner’s death. Failure to empty the inherited IRA by the 10^th year can result in hefty penalties on the undistributed funds.

What is a 1099-R form?

Form 1099-R is an IRS tax form that is used to report the distribution of retirement benefits such as annuities, pensions, and retirement plan distributions. It is equivalent to a W-2 form which employees receive annually, but the 1099-R is for people receiving retirement income. Like a W-2 form, the 1099-R form is sent at the end of each year when you receive retirement income.

If you inherit an IRA, the IRA custodian will issue a 1099-R form for each year you take distributions from the retirement plan. Form 1099-R provides important information, including the total distributions taken from the inherited IRA, the taxable portion of the distribution, and any federal taxes withheld.

Although the 1099-R tax form is linked to the deceased person’s IRA, it will be issued in your name. You must provide the information provided in the 1099-R form on your annual tax return.

Does an inherited IRA count as income?

Any distributions taken from an inherited traditional IRA are treated as ordinary income and are taxed at your income tax bracket rate. A traditional IRA is funded with pre-tax contributions, and this means that the contributions and earnings have not been taxed.

If you take a lump sum distribution from the inherited IRA, it will push you to a higher tax bracket depending on the amount of distributions you take and other sources of income. If you want to avoid a high tax bill, you can use several strategies, including spreading distributions over several years.

If you inherited a Roth IRA, and the original IRA owner held the account for at least five years, distributions taken from the inherited IRA will be tax-free. A Roth IRA is funded with after-tax contributions, and qualified distributions from the account are not subject to income taxes.

However, if the inherited Roth IRA does not meet the 5-year requirement, any earnings withdrawn from the account will be considered an income, and subject to income taxes. The contribution component of the distribution will be tax-free since taxes were paid at the time of contribution.

How to report inherited IRA distributions

When reporting inherited IRA distributions on your tax return, you should review the 1099-R information provided by the IRA custodian. The tax form provides information about the distributions you received from the inherited IRA during the tax year.

Here are important codes to review:

Box 1- This code shows the gross distribution taken from the IRA.

Box 2a- This code indicates the taxable portion of the IRA distribution. If you inherited a traditional IRA, the amount indicated will be the full distribution.

Box 4- This code indicates the federal taxes withheld by the IRA custodian from your distribution.

Box 7- This code indicates the type of distribution. Code 4 indicates distributions due to death, while Code T or Q indicates qualified or non-qualified Roth IRA distributions.

You will be required to report this information on Form 1040 of your annual tax return. Enter the gross distribution amount on Line 4a of Form 1040, and the taxable amount on Line 4b. For an inherited traditional IRA, the taxable amount will be the full distribution. However, for a qualified Roth IRA distribution, the taxable amount will be zero.

If the IRA custodian withheld a portion of the distribution for federal income taxes, you should also report this amount on Form 1040.

Is there a penalty for not taking RMD on an inherited IRA?

The IRS requires IRA owners to take required minimum distributions from their tax-deferred retirement savings each year starting at age 73. This rule carries over to the beneficiary of the IRA, and beneficiaries who inherit the IRA must take RMDs depending on when the original IRA owner died.

A designated beneficiary who inherits an IRA will be required to empty the IRA by the 10th year following the year of the death of the IRA owner. If the IRA owner had started taking RMDs, the beneficiary may be required to take the mandatory distributions during the 10 years.

If you fail to take the required distribution by the applicable date, the IRS will impose a 25% penalty for every dollar you did not withdraw. However, if you correct this failure within two years, the penalty will be reduced from 25% to 10%.

The RMD rules for inherited IRAs do not apply to certain eligible designated beneficiaries, including the surviving spouse, minor child, disabled, chronically ill, and beneficiaries who are no more than 10 years younger than the IRA owner.