@bjohnonly wrote:
thank you for your quick reply, sir! maybe this is my mistake? what i don't understand is how can the money be taxed twice? federal taxes and estate/inheritance taxes?
for clarification, even when funds are pulled from 401k or 403b for deposit into an official estate with an EIN number, the money is taxed?
Inheritance tax is something different. I have no knowledge of, but it usually only applies to very large estates, and if you are subject to inheritance tax, you probably need to hire a professional accountant.
The estate comes into existence to collect income paid to the deceased after they die. There are a couple of reasons the estate might receive a distribution from a retirement plan. One, it's the deceased person's RMD for the year. Two, the deceased did not have any designated beneficiaries on their retirement plans so the money goes to their estate. There might be other situations, you haven't specified yours, so I am at a bit of a loss here.
When the estate has income (paid to the deceased after their death), the estate must file a tax return and pay income tax. This might be a bonus from their employer, or royalties on a book or music, or in this case, a retirement account. It's all taxable income, just like it would have been taxable income if the person was alive. Estate taxes are extra taxes on large estates that also have to be paid, if the estate is large enough. That's why some people complain about "death taxes." Inheritance taxes are taxes the heirs pay on money they inherit. There are no federal inheritance taxes, but some states may tax certain inheritances, and yes, this can also sometimes be double-taxation, and that's why people complain about them.
In the case of retirement funds paid to an estate for whatever reason, they will be taxable income. The plan may be required to keep 10% or 20% as mandatory withholding. The entire amount is listed on the estate tax return as taxable income, and the estate gets credit for the withholding. If the estate owes less tax than was withheld, the difference will come back to the estate as a tax return.
Once the estate pays its tax bills (and any other obligations of the deceased) the remaining funds can be distributed to the heirs. If your state has an inheritance tax, those funds might be taxable again to the heirs, you would have to check state law on that. Money distributed from an estate to heirs is not taxable on their federal tax returns.
(To explain a slightly different way. You could inherit a 401k if you are named as a beneficiary. In that case, you don't pay tax when you inherit the account, but you pay income tax whenever you withdraw funds, because all withdrawals are taxed. Or, the 401k could pay to the estate, in which case the estate pays the income tax, and pays you the leftover cash. The leftover cash is not taxable to you by the IRS at that point, because the tax was already paid by the estate. In some cases, the cash might be taxable by your state, because they may have different rules.)
