When you inherit an IRA, or individual retirement account, from another person, you receive the payouts from the IRA. These payouts come with the same tax implications that existed for the original owner of the IRA. This increases your income tax in any year you receive payments.
You do not incur any upfront tax liability upon the inheritance of an IRA. As long as the funds remain in the IRA, you are not required to pay taxes on that money. The tax on an inherited IRA begins only when you start to receive distributions from the account, or when you cash out the account. The taxes are based on the total amount you take out.
If you receive monthly payments from an inherited IRA during a tax year, do not report those payments separate from the rest of your income. The distributions from an IRA are treated just like normal income for the purpose of taxes. You must add any IRA distributions to your employment income for the year. The net total of your income and distributions, after you write off any allowable expenses on your tax return, determines the tax you owe or the amount you get back.
If you inherit an IRA from anyone other than your spouse, including a parent or sibling, you cannot roll that IRA over into your personal account to continue accruing interest tax-free. If you want to put the money from the IRA into your own retirement account, you must cash out the IRA as a lump sum, add the entire distribution to your yearly income on your tax return, and pay the tax on the full amount. After that you can do anything that you want with the money, including contribute it to your own retirement account.
If you inherit an IRA from your spouse, you have the option of rolling the IRA over into your own retirement account, whether you hold that account through your employer or directly with a financial institution. Once the funds of an inherited spousal IRA are in your retirement account, you will not receive distributions until your own retirement. A spouse also holds the exclusive right to transfer ownership of the inherited retirement account into their own name.