Reporting an inherited IRA with a K-1 (1041)?

[dmertz]

Yes, the estate will need to remain open to receive the tax refund and distribute that to the estate beneficiaries.

The executor/personal representative should have been able to request that no taxes be withheld to avoid having to deal with tax withholding that cannot be credited to the beneficiaries on Schedules K-1, but it's almost certainly too late to do anything about that now since the plan has made the distribution and has withheld the default 10% in the absence of any instruction not to withhold taxes.

Depending on the timing of estate income and whether or not the estate's tax year has already been established by filing the estate's first Form 1041, the estate could potentially use a fiscal year to cause this income to appear on a Form 1041 for its tax year ending in 2024.

[bartostm]

Thanks for the response.  That was helpful.

[bartostm]

One follow up question.  If we pick an example with numbers, say the total estate was $100000 and thus the amount withheld was $10000.  To have the estate pay no taxes, we would need to push $100000 to the beneficiaries so they can file.  Also, the K-1s would sum to $100000 and provide the deduction on the 1041 needed to zero out the lump sum.  But there is only $90000 available to distribute since the IRS has $10000.  Does that mean in this case all $100000 can’t be distributed to the beneficiaries?  Or does the estate borrow the $10000 so that $100000 is distributed?

[dmertz]

I haven't encountered the situation myself, but the instructions for line 9 of Schedule B (Form 1041) say regarding tier 1 distributions:

Line 9 is to be completed by all simple trusts as well as complex trusts and decedents’ estates that are required to distribute income currently, whether it is distributed or not. The determination of whether trust income is required to be distributed currently depends on the terms of the governing instrument and the applicable local law.

So if the income is required to be distributed currently, it becomes part of the DNI deduction whether distributed or not.

[bartostm]

Thank you again for the information!

[bartostm]

One further thought on this topic.  I have seen in this post string that the estate can bear all of the tax burden and also that the beneficiaries bear all the tax burden, but does the IRS allow for a split of the tax burden?  My rationale is that estates don't file state income taxes but individual beneficiaries do.  I live in a state where the tax rate is a flat 4%.  So if the upper tax bracket is both 37% for individuals and for estates, then the marginal tax bracket for individuals is really 39% (35+4).  Thus, it seems there is a sweet spot whereby if the estate is large enough, if you reduce the size of the estate distribution so that you fall into the 32% individual tax bracket (32 + 4 =36% effective tax bracket), you will be at that "sweet spot" and any excess potential distribution can be retained by the estate and taxed there.

[dmertz]

Each state has requirements for filing estate income tax returns.  There might be a scenario where the estate's state tax liability if the income is retained could be lower than estate beneficiary's income tax liability on the same amount in a different state if the income is distributed.

[trust812]

dmertz, I know this is an old topic but I have a similar situation. If after the IRA money is distributed to the Trust and passed thru to the beneficiaries, how many years does the trust have to do this? I am trying to minimize taxes to the beneficiaries so that they won’t get walloped with a high tax bill.

[dmertz]

The terms of the trust and providing the trust document to the IRA custodian will determine whether the trust is qualified for look-through for determining required minimum distributions.  The terms of the trust will also determine how income is to be distributed to be distributed to beneficiaries.  How long the IRA can remain depends on the RMD requirements.

If the entire IRA has already been distributed to the trust, passing the income through to beneficiaries as distributable net income will allow the income to be taxed at the individual's tax rates rather than the generally higher trust tax rates.  Once received by the trust, the income must be taxable on the trust's income tax return for that trust year unless passed through to trust beneficiaries for taxation on the individual's tax return for the year that contains the end date of that particular trust income tax year.

[trust812]

dmertz, thanks!. It seems to me because of the IRS Secure Act, pass through distributions to Beneficiaries must be made within 10 years or distributions from the IRA which aren’t distributed will remain in the Trust and be taxed at the much higher Trust tax rate.

I found this on the internet about the IRS Secure Act:

”Pulling Back on the Stretch IRA

Just as there are rules about RMDs during the IRA owner’s life, there also are rules about distributions from an inherited IRA after the owner dies. Historically, the preferred payout for an inherited IRA has been the “stretch IRA,” where the post-death RMDs are stretched out over the life expectancy of the new IRA beneficiary. This allows the IRA assets to continue to grow tax deferred, often for many years after the owner’s death. The SECURE Act, passed in December of 2019, the SECURE Act 2.0 of 2022, and subsequent Treasury guidance3, have significantly reduced the ability to create a “stretch IRA.” For most individual beneficiaries, IRAs inherited after 2019 are subject to a 10-year rule that requires the IRA to be completely distributed by December 31 of the tenth year following the year of the IRA owner’s death. The 10-year rule may or may not include RMDs during the ten years, depending on whether the deceased IRA owner had reached their RBD at their death.Non-individual beneficiaries such as an estate, charity or certain trusts, are usually subject to either a 5-year rule, which requires distribution of the entire IRA by December 31 of the fifth year following the IRA owner’s death, or the “ghost life expectancy” rule, in which RMDs are spread out over the deceased account owner’s remaining single life expectancy. In such cases, the 5-year rule applies where the account owner died prior to their RBD, and the “ghost life expectancy rule” applies where the account owner died after their RBD and therefore had been subject to RMDs.

Certain beneficiaries, known as “eligible designated beneficiaries” or EDBs, are not subject to the new 10-year limitation. EDBs include: the IRA owner’s surviving spouse, the owner’s children while they are under age 21, certain individuals who are chronically ill or disabled as of the date of IRA owner’s death, and any person who is not more than 10 years younger than the IRA owner. EDBs can generally still enjoy the benefits of a stretch IRA by taking RMDs over a period that could be as long as their lifetime.”

[dmertz]

Don't confuse the requirement to make distributions from the IRA to the trust with whether or not the income from the trust can be distributed to beneficiaries.

Whether the IRA must be distributed within 10 years depends on whether the trust is qualified for look-through to the beneficiaries of the trust, whether all of the beneficiaries are Eligible Designated Beneficiaries, and whether the decedent died before or after the decedent's required beginning date for RMDs.

Whether income to the trust can be distributed to beneficiaries of the trust to have the income taxed on the beneficiaries' tax returns instead of being taxable at trust tax rates depends on the terms set forth in the trust document.

Also, the terms of the trust determine whether the inherited IRA can be split and the respective shares be allocated to the beneficiaries as inherited IRAs maintained for the benefit of the beneficiaries instead of being maintained for the benefit of the trust.  (Doing so does not change the RMD requirement that each beneficiary must then meet separately.)

[trust812]

dmertz, thanks. This is what my father’s Trust says.  I think the IRA  can be distributed to Beneficiaries over 10 years but not sure.

“(b) Distributions from Qualified Retirement Plans to Trusts

Unless specifically stated otherwise beginning with the year of my death, if any trust created under this trust becomes the beneficiary of death benefits under any qualified retirement plan, the Trustee shall annually withdraw from the trust's share of the plan the minimum distribution required under Internal Revenue Code Section 401(a)(9). The Trustee may withdraw additional amounts from the trust's share of the plan as the Trustee deems advisable, but only if the dispositive terms of the trust authorize the Trustee to immediately distribute the withdrawn amount as provided below. The Trustee shall immediately distribute all amounts withdrawn to: to my descendants, per stirpes, who are beneficiaries of this trust; and if no descendant of mine is a trust beneficiary, then to the trust's Income Beneficiaries in equal shares. Amounts required to be withdrawn and distributed under this Section will reduce mandatory distribution amounts under other provisions of this trust that otherwise require distribution of all the trust's income.

This Section's purpose is to ensure that the life expectancy of the trust beneficiaries may be used to calculate the minimum distributions required by the Internal Revenue Code. This Section is to be interpreted consistent with my intent, despite any direction to the contrary in this trust.

(с) Minimum Required Distribution

In administering the trust, the minimum required distribution for each qualified retirement plan for any year is the greater of: the value of the qualified retirement plan determined as of the preceding year end, divided by the applicable distribution period; and the amount that the Trustee is required to withdraw under the laws then applicable to the trust to avoid penalty. If a Grantor dies before the required beginning date for a qualified retirement plan, the applicable distribution period means the beneficiary's life expectancy. If a Grantor dies on or after the required beginning date for a qualified retirement plan, the applicable distribution period means the beneficiary's life expectancy, or the deceased Grantor's remaining life expectancy, if longer. Notwithstanding the foregoing, if a Grantor's death occurs on or after the required beginning date for a qualified retirement plan, the minimum required distribution for the year of death means: the amount that was required to be distributed to the Grantor with respect to the qualified retirement plan during the year; minus amounts actually distributed to the Grantor. Life expectancy, required beginning date and other similar terms used in this Subsection, are to be determined in accordance with Internal Revenue Code Section 401(a)(9)””

The IRA custodian is Charles Schwab. Do you know what information they need to start the ball rolling? Even if the beneficiary is listed as 100% going to the Trust will Schwab split the IRA into separate accounts depending on how many beneficiaries are named in the Trust? In my father’s Trust there are 4 equal 25% share Beneficiaries.

[trust812]

dmertz, thanks! This is what it says in my father’s Trust:

“(b) Distributions from Qualified Retirement Plans to Trusts

Unless specifically stated otherwise beginning with the year of my death, if any trust created under this trust becomes the beneficiary of death benefits under any qualified retirement plan, the Trustee shall annually withdraw from the trust's share of the plan the minimum distribution required under Internal Revenue Code Section 401(a)(9). The Trustee may withdraw additional amounts from the trust's share of the plan as the Trustee deems advisable, but only if the dispositive terms of the trust authorize the Trustee to immediately distribute the withdrawn amount as provided below. The Trustee shall immediately distribute all amounts withdrawn to: to my descendants, per stirpes, who are beneficiaries of this trust; and if no descendant of mine is a trust beneficiary, then to the trust's Income Beneficiaries in equal shares.

Amounts required to be withdrawn and distributed under this Section will reduce mandatory distribution amounts under other provisions of this trust that otherwise require distribution of all the trust's income.

This Section's purpose is to ensure that the life expectancy of the trust beneficiaries may be used to calculate the minimum distributions required by the Internal Revenue Code. This Section is to be interpreted consistent with my intent, despite any direction to the contrary in this trust.

(с) Minimum Required Distribution

In administering the trust, the minimum required distribution for each qualified retirement plan for any year is the greater of: the value of the qualified retirement plan determined as of the preceding year end, divided by the applicable distribution period; and the amount that the Trustee is required to withdraw under the laws then applicable to the trust to avoid penalty. If a Grantor dies before the required beginning date for a qualified retirement plan, the applicable distribution period means the beneficiary's life expectancy. If a Grantor dies on or after the required beginning date for a qualified retirement plan, the applicable distribution period means the beneficiary's life expectancy, or the deceased Grantor's remaining life expectancy, if longer.

Notwithstanding the foregoing, if a Grantor's death occurs on or after the required beginning date for a qualified retirement plan, the minimum required distribution for the year of death means: the amount that was required to be distributed to the Grantor with respect to the qualified retirement plan during the year; minus amounts actually distributed to the Grantor. Life expectancy, required beginning date and other similar terms used in this Subsection, are to be determined in accordance with Internal Revenue Code Section 401(a)(9)”

[trust812]

My father’s IRA is at Charles Schwab. He recently passed away. Do you know what a typical custodian like Schwab requires to start the ball rolling and how long it normally takes to get the distributions after a Trustor dies? Although, the Trust is the 100% Beneficiary on the IRA the Trust document states that 4 Beneficiaries have equal 25% shares. Do custodians such as Schwab typically split the IRA into separate accounts even if the Trust was listed as an 100% Beneficiary? 

[dmertz]

"This Section's purpose is to ensure that the life expectancy of the trust beneficiaries may be used to calculate the minimum distributions required by the Internal Revenue Code."

I suspect that this statement was intended to reinforce that the trust was to be qualified for look-through (provided the other conditions for look through are met).  However, it seems that this trust document was written before the SECURE Act took effect in 2020, which changed the conditions where the use of the life-expectancy of the beneficiaries would have previously been unconditional with look-through, and the trust was not updated to take the SECURE Act changed into account.

"If a Grantor dies before the required beginning date for a qualified retirement plan, the applicable distribution period means the beneficiary's life expectancy."

My understanding of the SECURE Act is that this is now permitted only if all of the beneficiaries are Eligible Designated Beneficiaries.  In fact, if there is more than one beneficiary, this treatment was not probably permitted as written even before the SECURE Act since the separate-accounts rule does not apply to trusts.  With a trust, RMDs must be based on the distribution period for the beneficiary with the shortest life expectancy and distribution period.

You need to obtain the service of a trust attorney who is familiar with the requirements imposed by the SECURE Act and the final regulations issued by the IRS :

https://www.federalregister.gov/public-inspection/2024-14542/required-minimum-distributions