New Tax Proposed for Inherited IRAs

Senator Max Baucus, who is the chairman of the Senate Finance Committee, has proposed a new tax law provision that would require all persons inheriting assets held in an Individual Retirement Account, such as a 401(k) or a traditional IRA, to remove all assets from the accounts within five years and pay the income tax on the accounts. Currently, the Internal Revenue Code permits beneficiaries to stretch out the distribution of the retirement account assets over the life expectancy of the designated beneficiary. For example, a ten-year-old beneficiary could stretch out the required minimum distributions over a period of seventy-three years.

The logic of Senator Baucus is that Individual Retirement Accounts are designed for retirement and not inheritance. Senator Baucus’ proposal was attached to the Highway Investment, Job Creation and Economic Growth Act of 2012. However, it was removed in Committee. Even though the proposal was removed from the Act, Senator Baucus has indicated strongly that he does want to attach it to a future bill.

The impact of this legislation would be significant on estate planning for several families. In addition, the tax impact on beneficiaries inheriting IRAs would be significant. The proposed rule would not apply to surviving spouses and other specific classes of beneficiaries, including, children with special needs.

While recently, this legislative proposal appears dead for the time being, the idea could easily come up again as Congress seeks diligently for revenue increases to address the daunting federal deficit.