Many beneficiaries miss out on one of the most significant tax deductions for inherited retirement-plan assets; the income with respect to decedent (IRD) deduction. If you inherited retirement plans assets, check with the person who filed the decedent's estate return, to determine whether the decedent's estate paid federal estate taxes on the retirement account balance. (For more on this subject, see Tax-Saving Advice For IRA Holders.)
As the beneficiary, you may be eligible to offset or reduce any incomes taxes you owe on your distribution of your inherited retirement account, by claiming a deduction for certain taxes paid by the decedent's estate.
For instance, if you inherited a traditional IRA and the decedent's estate paid $100,000 in taxes attributable to the IRA, the taxable amount of the balance you inherit may be reduced by the $100,000. You may even be able to claim the deduction before the estate taxes have been paid. For instance, in Field Service Advice 200011023, the IRS allowed the beneficiary to claim the IRD deduction, even though the decedent's estate had not yet paid the estate taxes.
The IRD is deductible as an itemized deduction on Schedule A of your income tax return. (To read more about deductions, see Which is better for tax deductions, itemization or a standard deduction?)
If you inherited retirement assets, be sure to work a tax professional who can help you to claim the IRD deduction.
To read more frequently asked tax questions, see How do I avoid paying excess taxes on securities I have sold?, How can I make sure I'm ready to file my taxes?, What aids will help me file my own tax return? and Common Tax Questions Answered.
Question answered by Denise Appleby, CISP, CRC, CRPS, CRSP, APA