Individual Retirement Accounts (IRAs) have many rules, and the penalties for failing to follow the rules can be painful. The taxpayer Elizabeth Beech found this out the hard way with her inherited IRA.
Elizabeth Beech inherited an IRA from her deceased mother. In 2008, Ms. Beech took a $35,348 distribution from the IRA. She took the distribution check and deposited it into a newly created “inherited” IRA account that was set up at another financial institution. She made the deposit well within the 60 day window and thought her distribution would be tax-free since she did a “rollover.”
Wrong! Code Section 408(d)(3)(C) prohibits rollover treatment in the case of an inherited IRA. An inherited IRA is defined as an IRA received on account of the death of another person, that other person not being the spouse of the inheritor. Tax-free “rollovers,” where the beneficiary takes a distribution then redeposits the amount within 60 days, are not allowed for inherited IRAs.
Unknown to Elizabeth Beech, the only way to move an inherited IRA to another financial institution is by trustee-to-trustee transfer. Instead, Ms. Beech should have instructed her IRA custodian to transfer the funds to her new IRA custodian. If the beneficiary of the IRA has control of the distribution (as in this example, has a check in hand), the distribution will be taxable.
Elizabeth Beech argued in Tax Court that she had the best of intentions and she meant to do a trustee-to-trustee transfer. The Tax Court said it couldn’t excuse Ms. Beech from the express prohibition of the law.
Lesson learned: Know the inherited IRA rules!
Melinda Nelson, CPA