IRA Cashout and Taxes Question

[swk7907]

Hi,

I was wondering if anybody here knows this answer. If an IRA is cashed out in the same tax year that an individual dies, are income taxes still owed on the proceeds or would those proceeds just count towards the estate and any potential estate taxes?

Long story short, I used to manage the finances for my aunt. Her health turned south and she moved in with my cousin (her son). In April of this year he liquidated and transferred her money from two Fidelity accounts (a rollover IRA and a taxable account) and the money was sent to her. I believe it was just put into a bank account in her name.

She passed away a week ago and my father and I are trying to figure out the tax implications of his actions. At the time I told my father that this action would trigger signficant tax implications unless they opened a new IRA account for her. My father didn't want to get involved. Now my father needs to help my other cousin (aunt's daughter) determine what she is owed from the estate.

I know my aunt would have owed income taxes on the IRA on her 2023 tax return however since she died this year I didn't know if that becomes null and now it just goes towards potential estate taxes which she won't have since her estate will be under the exemption.

Thanks for the help.

 

[PaunchyPirate]

It certainly will not become a null tax event. The income from the withdrawal will need to be reported on the final tax return for your aunt. Whether taxes are due will be determined by how much her overall income was prior to her death.

Unless it was perhaps rolled over to another IRA within 60 days of the withdrawal.

I don’t know anything about estate taxes that may also be due. That would depend on the state, I’m sure.

 

[frayne]

Consult a tax pro but one would think the tax would be due for the year the tax event took place.

 

[Montecfo]

Income taxes are due for the decedent's final tax year.

Estate taxes aka death taxes are another matter entirely.

 

[bingybear]

did the aunt have a beniferary ?

 

[SecondCor521]

Hi,

I was wondering if anybody here knows this answer. If an IRA is cashed out in the same tax year that an individual dies, are income taxes still owed on the proceeds or would those proceeds just count towards the estate and any potential estate taxes?

Long story short, I used to manage the finances for my aunt. Her health turned south and she moved in with my cousin (her son). In April of this year he liquidated and transferred her money from two Fidelity accounts (a rollover IRA and a taxable account) and the money was sent to her. I believe it was just put into a bank account in her name.

She passed away a week ago and my father and I are trying to figure out the tax implications of his actions. At the time I told my father that this action would trigger signficant tax implications unless they opened a new IRA account for her. My father didn't want to get involved. Now my father needs to help my other cousin (aunt's daughter) determine what she is owed from the estate.

I know my aunt would have owed income taxes on the IRA on her 2023 tax return however since she died this year I didn't know if that becomes null and now it just goes towards potential estate taxes which she won't have since her estate will be under the exemption.

Thanks for the help.

What you're hoping to be true is unfortunately not true. Income taxes and estate taxes are different, and they both are applied independently.

As far as income taxes goes, everything that happened before she passed away will be reported on a 2023 Form 1040 as usual and in the same way as if she had lived the entire year. The two main differences are that the executor of her estate will be responsible for filing the return and paying any tax due out of estate funds (or depositing any refund into an estate account), and there is a place to notate at the top of the return that the taxpayer died during the year.

The IRA custodian and taxable brokerage firm will send tax forms to her mailing address. For the IRA, there will be a 1099-R sent, and the entire amount will be taxable unless she made nondeductible contributions (unlikely). For the taxable brokerage account, there will be (usually) a consolidated 1099 which will usually include a 1099-DIV, 1099-INT, and 1099-B. The information from those forms will also go onto her final 2023 1040.

The 1099-R and consolidated 1099 tax forms (along with any others, like a SSA-1099 if she received Social Security benefits) will be sent next January. The executor probably wants to submit a change of address to the post office to forward her mail to their house.

Frequently someone who passes away during a tax year has significant medical expenses. If this was the case with your aunt, her executor should make an effort to collect all of those medical out of pocket expenses and see if it would be helpful to itemize. This can include Medicare premiums, prescriptions, hospital bills, durable medical equipment, doctor visits, and insurance premiums. Don't forget any taxes paid and any gifts to charity which might help increase her itemized deductions and reduce her final income tax bill.

If she lived in a state which has a state income tax, the executor should also file a final state income tax return.

...

Estate taxes are due if the value of her estate (essentially all of her assets minus certain liabilities) at her death is over $12.92M, which is uncommon and sounds like it doesn't apply.

Depending on her state of residence, there may be state-level estate or inheritance taxes. A quick google search should tell you if this applies. For the states which do have estate or inheritance taxes, they often have lower limits, so her estate might owe these kind of taxes to the state even if it doesn't owe federal estate taxes.

...

There is a third category of taxation, and that is on any income that her estate earns after she dies but before her assets are distributed. For example, if she owned a stock which paid a dividend after she died. If the total of this kind of income is over $600, then her executor should also file a Form 1041 (and any state equivalent form). This is unlikely.

 

[CRLLS]

SecondCor521 has it right. income taxes must be filed on behalf of the decedent for money they earned up to the day of their death. Usually, it is the Executor who files those taxes, both federal and in a state that taxes income. From there forward, the estate must file taxes for money the Estate earns after the decedent passes. In the year of death, 2 sets of income taxes get filed, the individual and the estate.

 

[swk7907]

Thanks for all of the help. She moved early in the year from Florida to Texas so state income or estate taxes shouldn't apply. Also her estate is well under the federal exemption level.

Her IRA did name her two kids as beneficiaries but I'm guessing that won't matter any more since it was cashed out earlier in the year and the check was sent to her. So that will clearly be income on her final tax return as indicated above. She did have significant medical expenses this year so hopefully that will offset some of this income.

I'm frustrated that my cousin liquidated her two Fidelity accounts including her IRA as I'm sure he had no clue the tax implications he would be triggering but in the end it is only hurting himself and his sister. I don't even know if she had a will or named an executor. My father is aware that her desires were for her assets to pass along to her two kids evenly and he is going to reach out to my cousin next week to start figuring things out.

Thanks again!

 

[SecondCor521]

^ You're correct that the beneficiary designations don't matter any more once the account is closed out.

If there were any money left in the checking account, then that money would pass according to the TOD designations (like a beneficiary, but for bank accounts) on the bank account if any (unlikely in this case). Or according to her will if she had one. Or state intestacy laws if she didn't.

If she didn't have a will, then a family member can apply to the local court to be the executor if they want to. Texas may have small estate procedures which are usually simpler/faster/cheaper and might apply in her case.

 

[pb4uski]

... I'm frustrated that my cousin liquidated her two Fidelity accounts including her IRA as I'm sure he had no clue the tax implications he would be triggering but in the end it is only hurting himself and his sister. I don't even know if she had a will or named an executor. My father is aware that her desires were for her assets to pass along to her two kids evenly and he is going to reach out to my cousin next week to start figuring things out.

Thanks again!

Yup. Assuming that your aunt's IRA was significant, your cousin screwed up. That income could have been spread over 10 years for each beneficiary.

If the account that the proceeds went into had both cousins as beneficiaries then all is well other than the tax cost associated with his bonehead move.

If he was a joint owner or the sole beneficiary of the account the proceeds went into then it might be fraud and your other cousin may have a case against him.

How did he have the legal authority to redeem her IRA or her taxable account?

 

[jazz4cash]

I'm frustrated that my cousin liquidated her two Fidelity accounts including her IRA as I'm sure he had no clue the tax implications he would be triggering but in the end it is only hurting himself and his sister.

If it was me, this is why I would stay out of it completely and encourage dad to do the same. You must’ve been pretty close to your aunt since you were managing her finances at one point but that relationship ended for some reason. Sorry for your loss but I think you may be stepping into a situation where you will take some responsibility for another’s actions.

 

[Montecfo]

Yup. Assuming that your aunt's IRA was significant, your cousin screwed up. That income could have been spread over 10 years for each beneficiary.

If the account that the proceeds went into had both cousins as beneficiaries then all is well other than the tax cost associated with his bonehead move.

If he was a joint owner or the sole beneficiary of the account the proceeds went into then it might be fraud and your other cousin may have a case against him.

How did he have the legal authority to redeem her IRA or her taxable account?

Hard to say without knowing amounts involved and everyone's tax rates.

 

[pb4uski]

Hard to say without knowing amounts involved and everyone's tax rates.

Agree, but that's why I prefaced "your cousin screwed up" with "Assuming that your aunt's IRA was significant".