1099-R filing. My wife received a distribution after her sister's passing. Does the penalty apply for this? If so, is it too late to transfer the money into another IRA?

When a taxpayer receives distribution from in inherited IRA. Box 7 on 1099-R should show distribution code 4 

In this case, the distribution is taxable but the beneficiary is not subject to 10% early withdrawal penalty. 

That's what I thought but the software updates the federal tax amount to INCLUDE the 10% penalty.

Can you double check your 1099-R input screen and make sure Box 7 has distribution code 4. One other way to check is, on forms mode you can search for Schedule 4 and line 59 shows additional tax on IRAs.

Also, once the money is distributed to a non-spouse beneficiary, it cannot be transferred to another IRA.  If your wife is eligible to make a new regular contribution to an IRA she can use the cash to do so, but that's entirely independent of the distribution reported on the Form 1099-R.

Thanks for the responses. The difference is driven by additional tax on the distribution rather than a penalty. It makes sense now.

I am glad we were able to help. Have a nice day and congratulations on completing your tax return!