Inherited IRA tax question?

Question

Let's say Adam has a rollover IRA worth $43k along with a taxable retirement account. Adam has a son, Bill, a friend, Charlie, and no wife. Bill is 16 years old and Adam has terminal cancer. Since Adam knows he is going to die, he sets up a trust and asks Charlie to take care of it until Adam is 21. Adam also tells Charlie he can take $10k out as payment.

Bill has now turned 21. Charlie transfers the taxable account to Bill without a problem. Charlie then takes a full distribution from the rollover IRA. For some reason, Adam named Charlie as beneficiary instead of Adam. Charlie takes the $43,000 distribution and sends a check for $31k to Bill. Charlie explains he took the $10k that was promised him as payment, along with $2k to pay for the tax.

And the problem is... what does Bill claim on his tax returns? Does he claim $31k, or does he claim $43k with a $12k deduction for investment expenses?

Also, nothing with the story can be changed. Thank you for your help.

Answer 1

Something is wrong in your question.  If Adam has the terminal cancer, why does he have to wait until he is 21? You mixed your names up.

Apart from which, if the son inherited the rollover IRA, he cannot take the distribution without paying regualr income taxes on it, so he would owe taxes on the full $43K.  The $10K "payment" would come out of the AFTER-tax balance of maybe $30K, so the son would claim a $10K expense against his declared $43K inheritance.  And Charlie would pay tax on the $10K as income to his business...

I think!

Answer 2

Charlie was promised $10K and not a penny more. He is stealing the $2k with the excuse that its to pay for tax.  He is supposed to pay his income tax with HIS pay of $10k which would leave him $8k.

Also, what control does Bill have as to what tax bracket Charlie is in? If Charie is in the 20% bracket, Bill cant do anything about that so why does he have to pay at that rate. In other words, the $2k is just being stolen.

but say its all in the up and up...why would Bill pay tax on the whole $43k if Charlie is taking $12k and claiming he is paying tax on it.

so Bill would only have to report $31k and when the tax man comes a calln' Charlie would be involved in an audit too.

If you are Bill....beware of Charlie.  He is a scammer and not a friend after all.

Answer 3

This is clearly homework.

Charlie as beneficiary has to report the full amount of the IRA.

His gift to Bill is not deductable--in fact it creates a filing requirement for a gift tax return. And he has zero "investment expenses."

The fact that Charlies is fulfilling Adam's wishes are moot.  Charlie had a limited time to disclaim the money back to the estate and that time has long passed.

The $10K probably won't even cover the tax bill....

For extra credit, explain how Charlie will cover the 50% excise tax for failure to take minimum required distributions form the IRA....

Charlie, the friend has made a common mistake of not understanding how an IRA works.  Charlie will get the 1099-R for the full distribution (since he's listed as beneficiary).  If he is in the 25% tax bracket, he will owe more than $10K in tax.  He was *also* required to take minimum distributions each year and since he didn't he'll owe a nasty 50% penalty.  If the father died before reaching 70.5, Charlie only had 5 years to empty the IRA and pay the tax....