With no designated beneficiary, there was never any option to roll the lump-sum pension distribution over to an inherited IRA. The only option in such case is a taxable distribution to the estate that is ineligible for rollover.
The distribution is reportable on an estate income tax return, Form 1041. Generally, the taxable income will be distributed to the estate beneficiaries, in this case the trust, passed through on Schedules K-1. The trust will then report the income from the Schedule K-1 on its own Form 1041 and, depending on the terms of the trust, potentially distribute this income to trust beneficiaries, passed through on Schedules K-1 to be taxed on the beneficiaries' tax returns. The estate and trust each take a deduction for distributable net income and certain other deductions. If any amount remains taxable to the estate or trust, the estate or trust is responsible for paying the taxes on that portion.
It's unfortunate, but may people make this major mistake of making their estate the beneficiary of plans like pension plans and 401(k) plans, leaving the estate beneficiaries with the unfavorable tax consequences. Whoever set up your father's estate plan in a way that forced this lump-sum pension distribution likely taxable in a single year seems to have done less than ideal job.
