Inhertied IRA and the Savers Credit
Client in the US Navy contributes to his TSP. Grandmother dies late in 2011 and leaves him funds from an IRA that was distributed in 2011. Do the distributions from an inherited IRA reduce the savers credit?
The publications indicate that the amount of distribution from a Traditional IRA will reduce the savers credit. The spirit of the law is to prevent taxpayers from taking a distribution from their own retirement plans and adding to another just to get the credit. I cannot find any reference to the impact of a distribution from an inherited IRA.
I would argue that the inherited IRA is not the same as a traditional IRA. Inhertied IRAs have attributes such as mandatory RMD and contributions are not allowed to the inherited IRA. Thus it is not a Traditional IRA
What is the opinion of other advisors?
What is the tax code that describes the savers credit?
Permalink Submitted by Alan Spross on Tue, 2012-03-06 17:17
These distributions should NOT be required reductions under the Savers Credit. The credit is addressed in tax code Sec 25B. The following is copied from the applicable subsection:
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25B(d)(2) Reduction for certain distributions
(A) In general.–The qualified retirement savings
contributions determined under paragraph (1) shall be
reduced (but not below zero) by the aggregate
distributions received by the individual during the
testing period from any entity of a type to which
contributions under paragraph (1) may be made. The
preceding sentence shall not apply to the portion of any
distribution which is not includible in gross income by
reason of a trustee-to-trustee transfer or a rollover
distribution.
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While an inherited IRA is still a traditional IRA, no contributions are allowed to be made to an inherited IRA. Therefore, a taxpayer should take the position that an inherited IRA is such an entity if the IRS will recognize the inherited status as an entity unto itself for these purposes. The fact that the distribution was required under 401(a)(9)b lends logical support to this position, but RMDs themselves are not excepted because an IRA owner taking RMDs is no longer considered (in theory) to be saving for retirement.
The 1099R for these distributions will have the death code 4 in Box 7, so the IRS can clearly see that the IRA is inherited. I recommend NOT showing a reduction on Form 8880, but be ready to support the position with the IRS by citing the above subsection of Sec 25B.
With respect to the added AGI resulting from the distribution, there is no exemption for that. The AGI might eliminate the credit on it’s own, but would not affect more than the actual year of the distributions vrs the 3+ year testing period for reductions. Client can of course manage that income by not taking out more than the RMD.