I inherited an IRA account. How is that taxable income to me?
Same as Decedent
When you inherit an IRA, your basis in the account is the same as the decedent’s basis. For traditional IRAs, that’s the amount of any nondeductible contributions made to the account. For Roth IRAs, the basis equals the amount of total contributions, because all Roth IRA contributions are nondeductible. For example, if the decedent had a $20,000 basis in his traditional IRA because over the years he made $20,000 of nondeductible contributions to the account, your basis is $20,000.
Significance of Basis
The basis of an inherited IRA is significant because it often determines whether you will pay taxes on all or a portion of your distributions from the account. Knowing the basis in the account allows you to avoid paying taxes on money that has already been taxed. If the decedent made nondeductible contributions to a traditional IRA, the decedent has already paid taxes on that money. If you are unaware of the decedent’s basis in the IRA, you’ll pay taxes on all of the distributions from the account, including the money that was already taxed.
Taxability of Traditional Distributions
If the decedent had a basis in a traditional IRA from making nondeductible contributions, you have to figure the tax-free portion each time you take a distribution. Divide the basis of the IRA by the value of the IRA at the time you take the distribution to figure the tax-free percentage. Then multiply the percentage by the amount of the distribution. Finally, subtract the tax-free portion from the old basis to find the remaining basis. For example, say you inherit a traditional IRA with a basis of $20,000 and you take a $10,000 distribution when it is worth $100,000. The tax-free portion of the distribution equals 20 percent, or $2,000. Your remaining basis in the account is $18,000.
Once you know the decedent’s basis, it is helpful to discuss your options and requirements with a tax advisor to insure you understand the tax implications.