I am looking for some guidance on a relatively unique situation and was wondering if you could help me out.

If a client has cost basis in their IRA, what happens at their death?

For example, Mr. Smith currently dies with a $1,000,000 IRA with $100,000 of cost basis (through non-deductible contributions). This IRA is inherited by his three kids (non-spouse) who put the funds into a Beneficiary IRA. So now each of the three kids as a $333,333 Bene IRA that has to be drawn to zero over ten years. In year 1, the Beneficiary withdraws $30,000. Is all $30,000 taxable or is there some portion of the non-deductible component that carries over to the kid making it less than $30,000 that is taxable?

My answer:

If a client passes away, then the beneficiary (ies) must file form 8606 in order to claim the non-taxable portion of the distribution. When the client makes non-deductible contributions during his lifetime he is required to file form 8606 every time. This form will keep track of the total basis on line 14. The beneficiary will file form 8606 to claim the non-taxable portion, and non-taxable distributions will be pro-rated with the distributions that are taxable.

In the case of Mr. Smith, from my understanding here is how the situation would play out. Each kid will inherit $333,333 and will file form 8606 when they take distributions. Each child will have $33,333 in total basis on their 8606s. If the beneficiary withdraws $30,000 in year one, they will file form 8606 and their distribution will be prorated. $3,000 will be non-taxable, and $27,000 will be taxable.

Is my answer a correct understanding of form 8606 rules?

Thank you for your help!