My dad died & left an IRA which got cashed out as unclaimed property in Oregon. Will this be taxed as capital gains or income or not taxable because it's an inheritance?

[jennaspier]

My dad had an IRA with my 2 children listed as beneficiaries. When he died in 2009 at age 64, the money was being held by a company in Maryland called Stifel. A few years later, for some unknown reason, Stifel sent the "unclaimed property" to the State of Oregon Dept. of State Lands. Oregon is now issuing checks from the IRA, which they took upon themselves to cash out, to each of my kids. How do I claim this money? Will I receive a 1099-R and have to pay capital gains or is it considered an inheritance and not taxable? Also, since the money belongs to my kids but the check is being issued in my name since my daughter isn't 18 yet, do I claim it on my taxes or do I need to do a separate tax return for each of the kids? I know this is a complicated question so thank you in advance for any help!!

[macuser_22]

If the children were named beneficiaries then they owned the IRA as of the time of death and the IRA trustee should have either moved the money into separate inherited IRA's for each child that remained in the name of the deceased or distributed the money to each child if that was what was wanted.  If remaining in an inherited IRA, they would be required to take RMDs (Required Minimum Distributions) each year.

Was the IRA trustee notified of the death?  Did they send letters to the children (or addressed to the beneficiaries through the address that they had on record)?

You don't claim the money, the children must report it on their own tax returns if required to file.    I have never heard of such a thing as an IRA with named beneficiary becoming unclaimed property without many letters being sent first.

There must have been some breakdown in communications if nothing has been done since 2009.   I have no idea how the State will report this.

(User @dmertz  do you have any insight on this ?)

[fanfare]

my fiduciary has no address on record for beneficiaries. It would be impossible for them to be contacted.
It's up to them to contact the fiduciary.

Also, my understanding is that unclaimed funds are not considered income.

[SweetieJean]

 However, any interest that had accrued would be taxable.

[jennaspier]

No letters were sent to me or my kids. We had no idea the IRA even existed until Stifel called me to tell me they had returned the funds to Oregon (they were still in the form of shares at that time, until Oregon decided to cash it out) and Stifel told me the website to go to for the unclaimed property. So I did that, filled out and sent in the paperwork, and now everything is done and they are cutting the checks, one in my son's name because he is over 18 and one in my name on behalf of my daughter since she is under 18. So I don't even know if it's taxable but I certainly don't want to assume and then they get in trouble for not claiming it on a tax return. And the State of Oregon said they can't give me any financial/legal/accountant info on how it will affect our taxes so I'm totally confused and just don't want to make any mistakes with this strange situation. Thank you so much for the help! I wish they could just tell me whether to expect a 1099 or not. Seems like they should at least be able to give me basic info on what I need to do but they said they can't give any info like that because they aren't specialists in taxes.

[Critter]

Both the children have received TAXABLE IRA distributions and they will each report what they got on their own returns whether they get a 1099 or not.  The distribution would have been taxable on the decedent's return so it is also taxable on the beneficiaries returns.  You cannot report the distribution for the minor child on your return.

[TomYoung]

My FEELING is that the distributions, if deposited in an ordinary bank account, would be taxable, but I don't have a cite for that pro or con.  

My reasoning, such as it is: if an IRA owner could avoid distributions to beneficiaries being taxable to the beneficiaries by reason of having the IRA escheated to the state, then what a slick planning tool that would be for someone knowing that they are not going to make it to the point of having to take RMD's.  They tell the beneficiaries to check the state's escheated funds page every day and call the minute the IRA pops up.

Perhaps someone has a better answer from the standpoint of "support'.  This has to have happened a few thousand times since IRA's were invented.  

[jennaspier]

I would think so too Tom. I just haven't been able to find any concrete answers, even in Google. It's very odd.

[dmertz]

Assuming that your dad had no basis in nondeductible contributions, the entire amount is taxable income to the beneficiaries (your children) and must be reported on the children's tax returns.  (I assume that the amount of this unearned income to each child is more than $1,050, requiring each child to file.)  This income might be subject to kiddie tax, calculated on Form 8615.  If proper Forms 1099-R are not issued to the children, substitute Forms 1099-R with appropriate explanation will probably be needed.

As macuser_22 said, by operation of law the IRA became an inherited IRA upon the death of your dad, maintained for the benefit of your children as the beneficiaries, even though the IRA custodian might not have been aware of your dad's death.  Also note that since these funds have been distributed and the beneficiary is not your dad's spouse, there is no option to get the money back into an inherited IRA.

Because the money was distributed late (depending on your dad's age, either RMDs or the 5-year deadline was missed), your children's tax returns should probably include Form 5329 requesting waiver of the 50% excess accumulation penalty.

[jennaspier]

Thank you all so much for your advice. What is an RMD? Please excuse my ignorance.

[macuser_22]

RMD = Required Minimum Distribution.

<a rel="nofollow" target="_blank" href="https://www.irs.gov/publications/p590b#en_US_2017_publink1000230760">https://www.irs.gov/publication...>

Quote:
"Owner Died Before Required Beginning Date

If the owner died before his or her required beginning date (defined earlier), and you are the designated beneficiary, you generally must base required minimum distributions for years after the year of the owner's death using your single life expectancy shown on Table I in Appendix B as determined under Beneficiary an individual , later.

See 5-year rule , later, for situations where an individual designated beneficiary may be required to take the entire account by the end of the fifth year following the year of the owner's death."
end quote

The 5 year rule allows the entire amount to be distributed within 5 years.   In your case both were missed.

[Opus 17]

An IRA is one of the exceptions to the usual rule that inheritances are not taxed.  Because IRA money is not taxed when it is deposited, it is always subject to regular income tax when withdrawn.  (Regular income tax, not capital gains rates.)

With an inherited IRA, you have the option of withdrawing the entire amount as a lump sum, in which case you don't pay the 10% early withdrawal penalty.  (Or you can do some other things, but those options no longer apply.)

So I would say that any money you receive from the state that was derived from an IRA, is taxable as regular income. (That would include any interest that was earned after your father's death.)

[macuser_22]

You never pay the 10% early distribution penalty for an inherited IRA - that does not apply.   As @dmertz stated above, the RMD is still required even if the existence of the inherited IRA was unknown.   Since the funds were transferred to the state of Oregon, it is not clear to me just HOW the state will report this.  Since the state is not a financial institution I have never heard of a STATE issuing a 1099-R.    Reporting this might not be simple.

[Opus 17]

I would report it as other income on line 21, even if the state does not issue a 1099.

Under normal circumstances, the person who inherits the IRA must withdraw all the money within 5 years, or take a lump sum, or take distributions spread out over their life expectancy.

@dmertz is pointing out that since the heirs didn't take a distribution within 5 years, their only remaining option is to take small withdrawals spread out over their life expectancy.  But I don't see how that can possibly apply in the case where the IRA trustee has turned the money over to the state's unclaimed funds office.  There is no way now to put the money back into an inherited IRA, and no way to take small annual payments from the state -- they'll pay it all out.  So I think the only thing that will actually work is to report the entire amount as Other Income.  Then the heirs can do whatever they want with the money.

[macuser_22]

As far as I know there is no "waver" of the RMD requirement of either the 5 year rule or yearly distributions based on the beneficiaries life expediency unless the IRS grants a waver which can only be applied for with a 5329 form for each year that the RMD was missed  - ignorance if the inheritance would be a valid reason when applying for the waiver.

I know of nothing in the tax law that the RMD requirement can just be ignored in a case like this when the inheritance was unknown to the beneficiary until after the RMD dates had passed.    I also do not know how a IRA benficuary can claim a distribution (no matter how late) as other income.