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?

[dmertz]

Since the deceased died before the Required Beginning Date for the deceased to have begun RMDs, distributions were required to have been made either annually over the life-expectancy of the beneficiaries beginning in 2010 (in this case, both would have had to have based annual RMDs on the life-expectancy of the older child, since the IRA was not split into separate accounts before the end of 2010) or for the IRA to be fully distributed by the end of 2014 under the 5-year rule.  Since neither was done, there are missed required distributions subject to an excess accumulation penalty unless the taxpayer (the children) requests and the IRS grants a waiver of the penalty.  These circumstances constitute reasonable cause for taking the required distribution(s) late.

The taxable result will be the same whether this unearned income appears on line 15 or on line 21 of Form 1040.  However, entering it as a Form 1099-R (by substitute Form 1099-R if the payer does not issue a Form 1099-R), causing it to appear on line 15, will allow TurboTax to prompt for the information necessary to prepare and include Form 5329 to request a waiver of the excess accumulation penalty.  Entering it as miscellaneous income will not cause TurboTax to generate Form 5329 requesting the penalty waiver.

[Critter]

Bottom line ... the poster really should talk to a local tax pro who can so some research and  advise them properly.

[Dgab]

@dmertz Great Response!

I have one additional question regarding keeping all the same parameters you described above (deceased not reaching distribution age, beneficiaries finding the account many years later so missed the 1year and 5year stipulations).

Option 1: move IRA to a beneficiary IRA and file a 5329 with letter of reasonable cause for the late RMD distributions

My question is, is there an option 2?

Option 2: Cash out the IRA and pay income taxes on the amount. Would I need to file the 5329 also in this instance?

[dmertz]

Dgab, the original question indicated that beneficiary was not the decedent's spouse and  the IRA was already cashed out, so under those circumstances your Option 1 is not possible.  Your Option 2 is the only option in that case and filing Form 5329 is required to request waiver of any excess-accumulation penalty if the distribution was made more than 5 years after the the end of the year of death of the decedent.

If the IRA was not already cashed out, transfer (not distribution and rollover) to an inherited IRA for the benefit of the designated beneficiary would be possible.  Default treatment in the tax regulations is RMDs based on life-expectancy, so as long as the IRA custodial agreement did not dictate the 5-year rule under these circumstances, distributions based on the life-expectancy of the designated beneficiary can generally be restored by making up the missed distributions and filing Form 5329 for each year that a life-expectancy RMD was made late, requesting waiver of the excess-accumulation penalty on each.

[Dgab]

@dmertz Thanks for your reply... just to clarify in the second option you detail (non-spouse, not distribution/rollover, past 5year mark), can the beneficiary still opt for complete distribution all at once and claim the total amount as income on their current year tax returns?

If a complete all at once distribution is possible after the 5year mark would one still need to file a 5329 and request a waiver since the beneficiary would be paying taxes on the whole amount at their normal income tax rate? In other words, would they have to pay both income tax on the whole amount and the potentially missed RMD distributions even though they do a complete payout, just late due to reasonable cause?

[dmertz]

The requirements are that some minimum amount be distributed from the IRA for a particular year.  There is no restriction on the maximum amount (up to the entire balance) that can be distributed from the IRA.

Under the 5-year rule, entire balance is required to be distributed by the end of the fifth year following the year of death of the decedent.  If you make the distribution of the entire balance after that, a late distribution, Form 5329 needs to be filed to request a waiver based on taking the necessary action to correct the distribution shortfall.  You would file a single Form 5329 for the year that is the fifth year following the year of death since that's the year that the minimum amount required to be distributed, the entire balance, was not timely distributed.

You include distributions as income on the tax return for the year in which you actually received the distribution, not as income on the tax return for the year in which the distribution was supposed to have been taken.  The only thing that you would potentially owe with the tax return for the year in which the distribution was missed is the 50% excess-accumulation penalty (an excise tax, not an income tax), but the IRS nearly always grants the waiver of that penalty for reasonable cause (and my guess is that the IRS considers reasonable just about any reason other than, "I did it intentionally").