Although honorable, Elroy Earl Morris’s decision did nothing to reduce his tax liability in a recent Tax Court decision [T.C. Memo. 2015-82, filed April 27, 2015].
In this case, Mr. Morris, an adult son was listed as the sole beneficiary of his father’s IRA, which had a balance of $96,422 at the time of his death. Mr. Morris took a lump-sum distribution of the account, which was reported to him on Form 1099-R (in addition to the annual distribution that had previously been made to his father prior to death).
A parent isn’t legally required to give children any inheritance. Whatever share their parent decides to give to one or more children is totally discretionary. Morris believed his father’s wishes would have been to share the IRA with his two siblings, so he sent them $37,000 in total.
He reported none of the distribution as income, based on advice he got from the local law firm probating his father’s estate. The paralegal handling most of the work said there would be no tax due on the IRA. She meant there would be no federal estate tax or state death taxes; he understood her to mean there would be no income tax to him.
The IRS sent Morris a notice of deficiency for 2011 ($27,037) resulting from the inclusion of the entire IRA in his gross income as well as a penalty ($5,387, later dropped by the IRS). The Commissioner’s determinations in a notice of deficiency are general presumed correct, and the taxpayer bears the burden of proving them erroneous. Morris argued that he shouldn’t be taxed on the entire amount because he shared his inheritance with his siblings. He claimed it would be inequitable to tax him on all the funds because of his voluntary action, and because he believed he received erroneous advice from the law firm.
Tax Court Decision
The Tax Court recognized that he acted honorably in carrying out what he thought were his father’s wishes. However, good conduct has no bearing on the tax treatment of IRA distributions. What’s more, tax advice (opinion) doesn’t impact tax treatment (law). Erroneous tax advice may affect whether any accuracy-related penalty applies, but the IRS did not try to collect any penalty in this matter.
2015 IRA Tax-Planning Note
A tax-planning deadline is approaching if you inherited an IRA last year. The IRA’s beneficiaries are set on September 30 of the year following the death of the IRA owner. Normally, heirs get to take distributions from inherited IRAs over their lifetimes. However, if just one beneficiary of the account isn’t an individual, the IRA has to be cleaned out within five years for all beneficiaries. The problem can occur when the owner names a charity or college as one of the beneficiaries. Solution: Redeeming a nonindividual’s IRA interest by September 30 can pay off handsomely. If the charity, school, etc. is paid off by then, the remaining individual beneficiaries can take distributions over their lives, enjoying more tax-free buildup inside the IRA.