Individual Retirement Accounts (IRAs) are wonderful tax and estate planning tools, but their Required Minimum Distribution (RMD) rules are onerous.

It is often said that the only two certainties in life are death and taxes. The IRS takes that truism to heart by first obligating you to calculate when you are likely to die and then making you pay taxes accordingly. RMDs are required on all traditional IRAs in and after the year the owner turns 70 1/2 years old. For inherited IRA accounts, RMDs are also obligatory in the year after the previous owner’s death.

A new RMD value must be calculated every year. In its simplest form, this year’s RMD is based on the value of the IRA at the end of last year and the life expectancy of the owner. However, figuring out the RMD of inherited IRAs is significantly more complex. The bereaved must face the loss of the grantor again every year, noting how many years it has been, how likely they themselves are to die, and how much of the inheritance remains in the account. It is a cruel rule.

All of this work is just so the government can grab its tax money early. It is counterproductive for everyone involved.

I was recently posed the following situation:

Help! I just inherited 50% of my father’s SEP and Contributory IRAs. My share is worth $500K. He had a nondeductible basis reported on his last return of around $72K. What does that mean for me? Can I inherit some of the basis as well?

This is a great question. On this topic, IRS Publication 590-B says:

IRA with basis.

If you inherit a traditional IRA from a person who had a basis in the IRA because of nondeductible contributions, that basis remains with the IRA. Unless you are the decedent’s spouse and choose to treat the IRA as your own, you can’t combine this basis with any basis you have in your own traditional IRA(s) or any basis in traditional IRA(s) you inherited from other decedents. If you take distributions from both an inherited IRA and your IRA, and each has basis, you must complete separate Forms 8606 to determine the taxable and nontaxable portions of those distributions.

The first part about a spouse is referring to the special spousal rollover inheritance option. When a spouse inherits retirement account assets, they have the right to do what is called a “Spousal Rollover” or “Spousal Transfer.” This is simply a transfer of ownership of the assets from the decedent to the spouse either via a rollover to a new account (the cleanest accounting) or by just treating the decedent’s IRA as though it were your own.

If you do the spousal rollover, that means you never need to take inherited RMDs but instead treat the assets as though they were your own, taking RMDs from the account per usual when you are over 70 1/2. It also means that these new assets from your deceased spouse commingle into your own IRA assets, combining both of your nondeductible basis together as well.

This is worth noting but not relevant to the reader’s question.

The second part of the IRS publication is applicable to all other heirs and relevant to the reader’s question. The IRS requires heirs to track the basis of each particular inherited IRA separately on its own Form 8606.

Although the IRS is not explicit on this, I would guess that the amount of basis that you inherit should be prorated based on the amount of the IRA assets you inherit. So, if you are inheriting 50% of the assets, then you would inherit 50% of the nondeductible basis.

As was the case for your father when he was alive, the nondeductible basis is shared by and spans across all IRA types. That means that if he had a third IRA on which you are not an heir, that IRA would also have a portion of the nondeductible basis. This would lower the percentage you inherit from a straight 50% down to only the pro-rated amount of the total IRA balance which you are inheriting.

Also, if any IRA is tapped for estate taxes, funeral expenses, charitable donations, or any other distribution before division for inheritance, then coffee-and-cream rules would mean that those distributions include some portion of the nondeductible basis as well, further reducing the amount leftover for inheritance.

If in addition to these inherited IRAs you personally need to file Form 8606 whether from Roth conversions or nondeductible contributions, then you may find that the tax program you use to file can no longer support your return’s complexity. You may need to paper file so that you can add in another Form 8606 or use a tax preparer to ensure that the basis is tracked. You will need to file a Form 8606 each year you have a nondeductible basis in order to keep it.

Tracking the nondeductible basis is very valuable. As RMDs are gradually taken from the inherited IRA, tracking the nondeductible basis will enable a portion to continue to avoid taxation.

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