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You've got a whole lot of issues here, some of which are legal. First the legal issue - I don't believe that a decedent can stipulate via a will what an IRA beneficiary does with the inherited IRA. I'm not an attorney, but my understanding is that you need a trust for that. Typical trusts of this type state that the income goes to the surviving spouse and that the principal goes to the beneficiaries upon the surviving spouse's death.

Assuming for now that either your language or your friend's language is imprecise and that what we actually have is a correctly formed trust, let's look at the tax issues.

The value of the IRA (or whatever the assets actually are) is included in the valuation of the decedent's estate. Whether federal or state Estate Tax is due should have been determined by the executor of the Estate. Any Estate Tax would have been paid by the executor out of the probate assets of the Estate. Inheritance taxes are assessed by some states. When they are, the tax is paid from the assets left to one or more classes of beneficiaries prior to the distribution of those assets. Usually, the state where the decedent lived is the state that gets to assess any Estate/inheritance taxes, but if the decedent owned assets in multiple states, taxes may be owed to multiple jurisdictions.

Thresholds for state Estate Tax and inheritance taxes are often much lower than the federal threshold so it's possible that some tax was paid.

Finally, since we're talking about an IRA (or a trust or both), income tax will be due on distributions from the IRA or trust in the usual manner. State taxation will generally occur in the resident state of the recipient of the income.

Ira
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