If a deceased relative leaves you an IRA disbursement, your obligation to pay taxes on it depends on the type of IRA you're withdrawing from. Knowing how much you have to pay in taxes helps you better budget for your withdrawals.
It's a pretty safe bet that you're going to be required to pay income taxes on distributions from a traditional IRA. Because the money wasn't taxed when the decedent made the contributions, the IRS is going to get its tax revenue regardless of who is taking out the distributions. However, if the decedent made nondeductible contributions, you will get a portion of the withdrawal out tax-free equal to the portion of the account consisting of nondeductible contributions.
If you inherit a Roth IRA, you might escape income taxes altogether. To take a qualified distribution, which means all the money comes out tax-free, the decedent must have had the Roth IRA open for at least five years before death. If not, then you get the contributions the decedent made to the account out tax-free, but once you've exhausted the contributions and start taking out the earnings, you must pay income taxes on those withdrawals.
The taxes on your distributions from an inherited IRA are the same as any other normal taxable income you have during the year. Unfortunately for your bank account, even if the gains in the IRA would all qualify for the lower long-term capital gains rates, all IRA distributions are taxed as ordinary income. For example, say your other income for the year puts you in the 25 percent tax bracket, $10,000 below the 28 percent bracket. If you take $12,000 out of the IRA you inherited from your relative, the first $10,000 is taxed at 25 percent and the last $2,000 is taxed at 28 percent.
Estate Tax Credit
Because the federal estate tax exemption is well over $5 million as of 2014, it's the rare exception rather than the rule that someone's estate is hit with estate taxes. However, if the person you inherited your IRA from did get hit with estate taxes, you can deduct the portion of those estate taxes paid on the amount of the IRA that you inherited in the year you take the distributions.
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