03 Oct How is an IRA left to an estate taxed?

Q. If an IRA owner dies and the account is paid to an estate, how are the IRS distributions taxed? Trusts can have a tax rate as high as 37%. Does the trust pay the tax and then so does the beneficiary, so the tax is paid twice?
— Taxed enough

A. You are correct about the high tax burden for trusts and estates.

Fiduciary — that is, estate and trust — income tax rates hit the highest level at a relatively low income level and, if the tax is paid at that level, it can be dramatically higher than if the same income were taxed under personal income tax brackets, said Michael Karu, a certified public accountant with Levine, Jacobs & Co. in Livingston.

If a non-individual, such as an estate, is the named beneficiary, there is a five-year rule for distributions.

However, the income, in and of itself, does not get taxed twice.

When the estate is the beneficiary, the executor can elect to have the estate pay the tax, which Karu said is usually not recommended, or the income can pass through to the beneficiaries of the estate using Form K-1.

“That is the more common method, as the funds usually will get distributed to the beneficiaries,” he said. “If the latter occurs, there is no tax at the estate/fiduciary level. The beneficiaries will report the income on their personal income tax returns and pay the tax.”

But Karu offered a word of warning:

“If income tax is withheld on the distribution to the estate, that withholding may not be able to pass through to the beneficiaries,” he said. “Be sure to check with a CPA or tax attorney.”

Karu said income tax is due on the distributed amount, whether it is 100% of the IRA, distributions using the five-year rule, or distributions made using the single life table.

“The ultimate tax should be paid by the final recipient,” he said.

On a related note, there could be two different taxes imposed, Karu said.

“When an individual passes away, a `photograph’ is taken and, depending on the size of the decedent’s estate and the relationship of the beneficiaries to the decedent, an estate and/or inheritance tax can be due,” he said. “That is different from income tax.”

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This story was originally published in September 2024.

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