NEW BERLIN, Ill. (TheStreet) -- Chances are, especially if you hold a significant amount of money in IRA accounts, you've heard about a "double tax" that may be a part of your account's future.Here's a brief explanation: When the owner of an IRA dies, assuming the size of the estate is greater than the exclusion amount, the estate has to pay tax on any amount above the exclusion. Presumably this includes an IRA account, 401(k) and other retirement plans ... and when heirs begin taking Required Minimum Distributions from the IRA account, they will have to pay ordinary income tax on the amounts distributed. Hence the "double" tax.
|Estate have to pay tax on any amount above the exclusion, but heirs have to pay ordinary income tax on Required Minimum Distributions from an inherited IRA. There might be a way out of this double tax.|
As the law is written, this year the estate tax exclusion is $5 million and step-up of basis is back in force. Again, if the funds are in an IRA, there is no step-up, although the basis of after-tax contributions and rollovers remains intact. So if your estate has the opportunity to be greater than $5 million in value, any amounts above that exclusion amount will be subject to the estate tax. If those assets that are above the exclusion amount include your IRA or other retirement plans, your heirs will also have to pay ordinary income tax on the distributions -- effectively paying tax again on the same money, the double tax. After 2012, the law is set to return to the $1 million estate tax exclusion, so we'll see what happens at that point. Income in Respect of a Decedent
One way your heirs can avoid some of the double taxation is to use Income in Respect of a Decedent rules, which essentially allows the heir to claim a deduction of any income taxed by the estate tax. It gets complicated, but if you keep good records and pay attention as you file your returns, some of the double taxation is eliminated.