IRA Death Benefit Issued as Distribution, not to Inherited IRA

Submitted by Geoffrey Kasher on Fri, 2023-10-13 17:01

The client died in 2022 with an IRA.

Her daughter was the bene.

An Inherited IRA account was set up to receive the funds.

The death claim form was mistakenly submitted as a distribution and not as a qualified rollover to the inherited IRA.

A check was received and deposited into the Inherited IRA.

Because the distribution form was incorrectly submitted, the daughter received a 1099 showing the taxable distribution.

As a result, the distribution was taxable.

At this point, the insurance company is not willing to correct the error.

2 questions

1. Are there alternatives? The client doesn’t want to engage the IRS because they fear an audit of some kind in the future.

2. What will be the tax consequence of moving the money to an individual account

TIA



Submitted by Alan - IRA critic on Fri, 2023-10-13 20:09

  •  Unfortunately there is no way to fix this error unless the insurance company made the error. Therefore, even if the client wanted to request a PLR from the IRS, that would be a total waste of time and money since the IRS does not make exceptions to this rather common and costly error.
  • It’s rare that the custodian for a non spouse inherited IRA would accept a contribution since neither regular or rollover contributions to such an account are not allowed. Acceptance of this deposit creates an excess IRA contribution which must be corrected by the extended due date which is Monday 10/16 to avoid a 6% excise tax. It’s probably too late at this point. Further, the excess must be removed by 12/31 to avoid a repeat excise tax for 2023. 
  • The original distribution must be reported as taxable income per the 1099R, and at this late date the excise tax for 2022 will also be due as reported on Form 5329. The IRA custodian that accepted this deposit did client no favors as they should have known that no such contribution can be made to a non spouse inherited IRA.

Submitted by Geoffrey Kasher on Sat, 2023-10-14 14:09

The check was made payable to Schwab FBO the bene. I spoke with Schwab and they didn’t accept it as a r/o instead as a transfer. The deposit into the inherited IRA was not reported to the IRS.In speaking with first level at Schwab it was suggested that they might be able to correct by saying it was depostied into the wrong account and move it to an individual account.

Submitted by Alan - IRA critic on Sat, 2023-10-14 14:23

  • Since there was a transfer instead of a distribution to the beneficiary there should have been no 1099R issued by the insurance company. Schwab has handled this correctly notwithstanding some miscommunication when they were contacted earlier. The beneficiary should contact the insurance company to have the 1099R corrected to 0’s as the IRS will expect the income to be reported per the 1099R. 
  • If this had been an employer plan instead of an IRA, then a 1099R coded G should have been issued and then reported as a direct rollover by the beneficiary.  She is sure that the account she inherited was an IRA?

Submitted by Geoffrey Kasher on Sat, 2023-10-14 16:23

It was coded as a transfer but a check was sent to the bene and she sent to schwab Insurance company says that since they have already “closed” 2022 there is nothing they can do  

Submitted by Alan - IRA critic on Sat, 2023-10-14 16:54

  • That is incorrect. Beneficiary should tell the insurance company that they are required to correct an erroneous 1099R form. If they refuse to do it, the beneficiary will have to request a Form 4852 from the IRS, which is a substitute for the incorrect form. The IRS will then contact the insurance company to address the difference in forms, so the beneficiary should inform the insurance company that they need to issue a corrected 1099R now or be contacted by the IRS later about this. Hopefully, that will entice the company to issue the corrected form. The following link is for the 4852 form and instructions: 
  • Form 4852 (Rev. September 2020) (irs.gov)
  • This should have been dealt with early this year. What is the status of the beneficiary’s 2022 tax return?

Submitted by Geoffrey Kasher on Sat, 2023-10-14 17:40

filed friday.I found out about the issue this past friday when the client called.insurance company is saying they issued the check as a distribution because of how the form was filled out. They rejected the idea that it should have been nigo because the check was not issued as requested. The instructions were fbo bene inh ira. 

Submitted by Geoffrey Kasher on Sat, 2023-10-14 17:41

the incoming check that schwab received was coded as a transfer

Submitted by Alan - IRA critic on Sat, 2023-10-14 19:28

  • If the request was for a distribution and the insurance company issued as a direct transfer, the company must report what they actually did, even if different from the request.  Oddly, the direct transfer was what should have been requested on the form in the first place. The company should not issuing a 1099R for a transfer. Is the value of this IRA high enough to warrant the hassle of these procedures to try to avoid a taxable distribution?
  • On the return filed yesterday, how did the beneficiary address the 1099R? 

Submitted by Geoffrey Kasher on Sat, 2023-10-14 20:30

That is the issue, the insurance company professed it as a full distribution. When the check came into Schwab they coded it as  transfer.IRA was 155k. Client claimed it as income. Said would refile once it was figured out. His concern is if he files the 4852 it may open him up to audit. The cpa advised against it

Submitted by Alan - IRA critic on Sat, 2023-10-14 23:27

  • Not a good decision. The beneficiary has just incurred a large tax bill by reporting a distribution when the funds were actually transferred into a beneficiary IRA. Annual beneficiary RMDs will be required if the client passed after their RBD, and the 10 year rule applies. All distributions taken from this inherited IRA in the next 10 years will be be taxed a second time. Schwab will report the value of this inherited IRA to the beneficiary and the IRS each year. Further, if the IRS determines that a distribution as shown on the 1099R was rolled into an inherited IRA they would treat this as an excess contribution with a 6% excise tax due each year the excess remains.
  • 1099R and similar forms that report transactions differently from what actually occurred present a tax time bomb risk because the inconsistency remains. Not fixing this error promptly could explode down the road into a much larger and costly problem including that audit that the CPA seems so concerned about. 

Submitted by Geoffrey Kasher on Sun, 2023-10-15 14:18

Initial distribution was taken before RBD.There are also funds in the inherited in excess of the 155k What If Schwab corrects the initial deposit into the inherited and instead moves it to a NQ account and client takes the 155 as a distribution?  Since Schwab didn’t report the deposit into the inherited ira. so, the 4852 is the right way to fix this?

Submitted by Alan - IRA critic on Sun, 2023-10-15 17:07

  • Yes. First, there needs to be some document such as an account statement showing that the inherited IRA was funded by a transfer, even though there is no other way to fund a non spouse inherited IRA. This documentation would assist the IRS in accepting the 4852 in lieu of the taxable 1099R. The inherited IRA would then be treated as such rather than an excess contribution. No correction would be needed. No taxes would be due until the beneficiary took distributions from the inherited IRA. If client passed prior to RBD there are no annual RMDs needed, but beneficiary would still benefit from taking voluntary distributions over the 10 year period rather than having a total distribution taken in year 10. An amended return should be filed for 2022 for a refund of the tax dollars already paid due to the incorrect 1099R. 
  • On the other hand, since Schwab accepted the transfer correctly, they would likely resist treating it as an excess contribution merely because the insurance company incorrectly issued a 1099R. As such any distribution would be reported on a Schwab 1099R as taxable, meaning double taxes.
  • As you can see, paying the taxes on the incorrect 1099R cost the beneficiary alot of money, and it did not even eliminate the problem of future double taxes when the inherited IRA is distributed.

Submitted by Geoffrey Kasher on Sun, 2023-10-15 21:08

Double tax being that he already paid the tax from the 1099R and will have to pay again when it’s distributed? Again, the mistake was noticed this past Thursday. Way to late to have done anything 

Submitted by Alan - IRA critic on Sun, 2023-10-15 21:54

Yes, unless the inherited IRA is distributed and coded as the removal of an excess contribution. But Schwab may not agree to treating this as an excess contribution when they received it as a transfer. The 1099R is inconsistent with the transfer that actually occurred, and if the insurance company refuses to correct that 1099R the end result could be double taxation. 

Submitted by Geoffrey Kasher on Mon, 2023-10-16 13:34

file the 4852 and see what happens?orgo the excess contribution route?

Submitted by Geoffrey Kasher on Tue, 2023-10-24 19:56

The insurance company won’t reissue the 1099Schwab will distribute as excess contributions. Rational, deposit was made last year and there have been trades on the account since then. Thanks again

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