For Americans dealing with the loss of a loved one, closing the decedent’s estate is a stressful and difficult enough process as it is. But for taxpayers whose loved one left them to inherit their IRA, the IRS just made it even more complicated — and expensive.
Prior to the 2019 passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, taxpayers inheriting a traditional IRA could hold onto it for as long as they wished until cashing it out, though they had to take the Required Minimum Distributions (RMDs) each year. Generally, this meant that they would wait until retirement to fully cash out the IRA, when the income from it would be subject to a lower tax bracket.
The SECURE Act changed that. The law introduced a new ten-year payout rule, by which time the inherited IRA (or Roth IRA, or 401(k)) had to be cashed out. Most tax professionals assumed that for traditional IRAs, this payout rule replaced the annual RMDs, as indeed Congress intended.
This assumption was strengthened when, in 2021, the IRS corrected a guidance that seemed to suggest that heirs would have to make annual withdrawals from their inherited IRA by affirmatively clarifying that the heir is “allowed, but not required, to take distributions” prior to the end of the ten-year period.
But then earlier this year, the IRS released yet another revision of Publication 590-B, the rules for the implementation of SECURE. This time, the IRS changed its mind, requiring heirs to take RMDs as well as cash out the IRA by the end of the ten-year period.
In effect, this requires affected taxpayers to both go through the complicated process of calculating their annual RMD from years one through nine as well as take the tax hit of cashing out the remaining amount at the end of year ten in order to minimize their tax liability. As a recent Wall Street Journal article on the issue noted, many taxpayers will probably just choose to take the hit of cashing out the IRA immediately rather than navigate this complicated system.
That will have a real effect on the tax burden heirs face, as their inherited IRA will be lumped into one large tax bill — and end up facing higher tax brackets. But for many, the ability to spread out their tax liability over ten years of tax returns won’t be worth nine years’ worth of complicated tax returns.
What’s more, the fact that the IRS did such a rapid about-face on the issue of RMDs means that many taxpayers are already out of compliance. Taxpayers who inherited an IRA in 2020 are now expected to have made an RMD in 2021, even though they had every reason to expect at the time that they did not need to do so.
At a minimum, the IRS should waive fees for RMDs not taken in 2021 to address this issue of retroactivity. But at a broader level, the IRS should adhere to congressional intent rather than taking such an active role in policymaking.
Should the IRS fail to revise this guidance once again to eliminate the RMD requirement, Congress should step in. Grieving taxpayers have more than enough problems without the IRS tossing another unnecessary complication on top.