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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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This is regarding my sister-in-laws estate. I am executrix.

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This is regarding my sister-in-law's estate. I am executrix. NJ estate taxes have been paid. She has 4 CD's, valued at $129,000. Two of her brothers are listed as beneficiaries on them, and we've been told they'll need to pay income tax on the amounts they receive. They then plan on signing the checks over to the estate, so that I can pay her outstanding medical bills. Her will designates three beneficiaries. All three of her brothers.
My question is regarding the tax burden on any of the remaining funds which I will equally disburse to the three brothers. The third brother's tax accountant told him that those funds will NOT be taxable. That I understand. But what about the funds redistributed to the original two brothers? They plan on opting to have 20% federal tax taken from each of their amounts, so will receive 1099's at some point. I my mind, they are basically paying tax on a value that they are not going to receive.
How does something like this get handled by IRS?
Thanks.
Arleen

LEV :

Hi and welcome to Just Answer!
Hi and welcome to Just Answer!
As a recipient of inheritance - the person does not need to claim it as income. Regardless of the value. Please see for reference IRS publication 525 page 34 (left column) -http://www.irs.gov/pub/irs-pdf/p525.pdf

LEV :

So if these are just regular bank's CD accounts - none is included into taxable income - neither for the estate nor for beneficiaries - and none is taxable for income tax purposes.
Thus your third brother's tax accountant seems as correct.
However - interest earned on these CDs is taxable - and will be reported on form 1099INT.
The interest earned BEFORE your sister-in-law's death is reported on her final tax return (form 1040). However the interest earned AFTER her death will be reported on the income tax return for the estate (form 1041) or by beneficiaries if the receive that income.
However the principal amount is not reportable and not taxable.
Let me know if you need any help.

Customer:

I'm sorry, I neglected to say that these are IRA cd's. I believe this makes a difference? The bank told us that the amounts are taxable.

LEV :

Yes - that does make a difference. While inheritance itself is not taxable - IRA accounts are treated differently - because the distribution from IRA is IRD (income in respect of the decedent) and it is taxable the same way as if it would be taxable for the decedent - that amount will be included into taxable income.

LEV :

If your mother made any after tax contribution into IRA - that amount is distributed tax free. But if all contribution were made on pre-tax basis - the full amount is taxable. When funds are distributed out - that income is classified an income in respect of a decedent (IRD). Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. Income in respect of a decedent realized AFTER the death is taxable the same way as it were taxable for the decedent. Income in respect of a decedent must be included in the income of one of the following.
--The decedent's estate, if the estate receives it.
--The beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it.
--Any person to whom the estate properly distributes the right to receive it.

LEV :

When distributed - that amount is reported on form 1099R - which will report amounts of total distribution and taxable amount - AND the amount that was withheld
- from 1099R box 1 - total distribution
- from 1099R box 2a - taxable part of the distribution - if your mother made any after tax contributions - that amount would not be included. Otherwise - amounts in box 1 and box 2a will be equal.
- from 1099R box 4 - that is the amount of tax withheld which is credited toward tax liability.
In general - instead of distribution - you may rollover funds into so-called "inherited IRA" and spread distribution over several years - thus effectively might reduce and defer your tax liability.

LEV :

Please be aware that 20% withholding is NOT a tax liability. The tax liability is determined when the person files his/her tax return. It may be more or less than 20%. There will be additional state income taxes as well.

Customer:

Aha, yes, I understand. So, in effect, the third brother does not have to pay income tax, but the two that are on the cd's do; on an amount that they are not actually going to receive. The final "pot" needs to be split into three. I'm thinking I'll pro rate the tax $'s that the two are paying, and then distribute the balance.

LEV :

Yes - you may consider possible tax liability when you will calculate amounts for distributions. However - that would not be simple - because the actual tax liability will be known when beneficiaries will file their tax returns (federal and state) - that will be most likely in Jan 2014.

Customer:

Correct, I've got it. Thanks. You've been very helpful!

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