Once a relatively obscure concept, “income in respect of a decedent” (IRD) may create a surprising tax bill for those who inherit certain types of property, such as IRAs or other retirement plans. Fortunately, there may be ways to minimize or even eliminate the tax bite.
Basic Rules
For the most part, property you inherit isn’t included in your income for tax purposes. Items that are IRD, however, do have to be included in your income, although you may also be entitled to an IRD deduction on account of them.
What is “income in respect of a decedent?” It is income that the decedent (the person from whom you inherit the property) would have taken into income on his or her final income tax return except that death interceded. One common item is the decedent’s last paycheck, received after death. It would have normally been included in the decedent’s income on the final income tax return. However, since the decedent’s tax year closed as of the date of death, it wasn’t included. As an item of IRD, it’s taxed as income to whomever does receive it (the estate or another individual). Not just the final paycheck, but any compensation-related benefits paid after death, such as accrued vacation pay or voluntary employer benefit payments, will be IRD to the recipient.
Other common items include pension benefits and amounts in a decedent’s individual retirement accounts (IRAs) at death as well as a decedent’s share of partnership income up to the date of death. If you receive these IRD items, they’re included in your income.
The IRD Deduction
Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that’s caused by having the items subject to the decedent’s estate tax as well as the recipient’s income tax.
To calculate the deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows:
- First, you must take the “net value” of all items included in the decedent’s estate. The net value is the total value of the IRD items in the estate, reduced by any deductions in respect of the decedent. These are items which are the converse of IRD: items the decedent would have deducted on the final income tax return, but for death’s intervening.
- Next you determine how much of the federal estate tax was due to this net IRD by calculating what the estate tax bill would have been without it. Your deduction is then the percentage of the tax that your portion of the IRD items represents.
In the following example, the top estate tax rate of 40% is used. Example: At Tom’s death, $50,000 of IRD items were included in his gross estate, $10,000 of which were paid to Alex. There were also $3,000 of deductions in respect of a decedent, for a net value of $47,000. Had the estate been $47,000 less, the estate tax bill would have been $18,800 less. Alex will include in income the $10,000 of IRD received. If Alex itemizes deductions, Alex may also deduct $3,760, which is 20% (10,000/50,000) of $18,800.
We Can Help
If you inherit property that could be considered “income in respect of a decedent,” consult with us for assistance in managing the tax consequences.