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Do I Pay City Tax on an Inherited IRA?

Original post by Amber Keefer of Demand Media

There are more ways than one to handle an inherited IRA.

Even though there are numerous tax advantages to inheriting an IRA, unless you follow IRS guidelines carefully, you could find yourself paying penalties and taxes. There are several options available to surviving spouses and non-spouse beneficiaries. Generally, state and local governments do not tax retirement income. However, the specifics of each taxing authority's exemption laws relating to state personal or local earned income taxes can vary.

Treating an Inherited IRA as Your Own

You can treat a traditional IRA that you inherit from your deceased spouse as your own as long as you name yourself as the account owner instead of the beneficiary. To transfer the IRA into your name, you must be the sole beneficiary and continue to make contributions to the account. You can defer distributions until the time the IRS requires you to withdraw the funds. The time when you must take your distributions depends on the type of IRA account, type of inherited IRA you open and the age of the original account holder at the time of death. If you inherit a traditional IRA from someone other than your deceased spouse, you do not have the option of treating the account as your own; therefore, you cannot make contributions to the IRA or roll over any amount of the IRA into another retirement account -- new or existing. In most cases, distributions you receive from pension plans and other retirement savings accounts are deductible from taxable income according to local tax laws.

Rollover

If you inherit a traditional IRA from a deceased spouse, you may choose to roll over the funds you inherit into another IRA account. You have the option of moving part or all of the money into one or more IRA accounts. The major benefit of an inherited or beneficiary IRA is that it allows you to continue tax-deferred growth of retirement savings until you must begin withdrawing from the account. If you are someone other than the deceased person's spouse, additional options include transferring assets you inherit to another account or transferring the assets to an inherited IRA and then taking a cash distribution of your share. Taking the cash requires you to include the money you receive in your taxable income for that year. This may also apply to paying local taxes.

Dates to Remember

Local governments do not tax all the same types of income that the federal government taxes. Generally, retirement income is not taxed. Still there are certain dates you must remember if you inherit an IRA account. In order to continue receiving IRS tax benefits, you must decide what to do with the account within nine months following the death of the original account holder. If you share the assets of the account with other beneficiaries, you can set up your own inherited IRA. You must set up an account for the portion you inherit by December 31 of the year following the original account holder's death.

Tax-Free Distributions

Although local municipalities usually do not include pension and retirement distributions as taxable income, when it comes to filing your federal individual tax return, a Roth IRA does not tax the distributions you take in retirement. If you inherit a Roth IRA, as long as the original owner held the account for at least five years before his death, you as a beneficiary are not required to pay federal income taxes on qualified distributions you receive from the account. You also have the option of converting a traditional, simple or SEP IRA that you inherit from your deceased spouse to a Roth IRA. Should you inherit a qualified retirement plan account from someone other than your spouse, you can transfer the inherited assets directly to one or more Roth IRA accounts.

                   

References

About the Author

Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering health, fitness and women's issues published in "Family Digest Magazine," "Chicago Parent" and "Woman's Touch." Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.

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