Key Takeaways
- Income earned before death but received after.
- Taxed twice: estate tax and income tax.
- Deduction available to reduce double taxation.
- Retains original income character when taxed.
What is Income in Respect of a Decedent (IRD)?
Income in Respect of a Decedent (IRD) refers to taxable income that a decedent earned or was entitled to before death but did not receive or report on their final tax return. This income is taxable to the estate or beneficiary upon receipt and also included in the gross estate for federal estate tax purposes, creating a unique tax situation involving both estate and income taxes.
IRD maintains its original income character, whether ordinary income or capital gains, and requires careful handling to avoid excessive taxation.
Key Characteristics
IRD has distinct features that affect how it is reported and taxed:
- Not included on final return: IRD is excluded from the decedent’s last Form 1040 since it was neither received nor constructively received before death.
- Retains income character: Whether ordinary income or capital gain, IRD keeps its nature when taxed to the beneficiary.
- Applies to cash and accrual basis: Cash-basis decedents’ IRD is reported by beneficiaries upon receipt; accrual-basis decedents include accrued income except certain deferred compensation on final returns.
- Subject to double taxation risk: IRD is included in the estate for tax and later taxed as income, though an itemized deduction can reduce this burden.
- Examples span multiple sources: From unpaid wages to retirement plan distributions, IRD covers diverse income types.
How It Works
IRD is included in the gross estate at fair market value, increasing the estate tax liability. When the estate or beneficiary later receives the IRD, it must be reported as income for that tax year, typically on Form 1041 for estates or Form 1040 for beneficiaries.
The Internal Revenue Code allows an itemized deduction for estate taxes paid on IRD, mitigating the double taxation impact. Proper timing and reporting are critical to optimize tax outcomes and comply with IRS requirements.
Examples and Use Cases
IRD commonly arises in various practical scenarios, helping you understand its real-world impact:
- Retirement accounts: Distributions from inherited IRAs and pensions are classic IRD examples, taxed as ordinary income upon receipt.
- Accrued interest: Bonds like BND or dividend-paying stocks such as VYM generate interest or dividends that qualify as IRD if unpaid at death.
- Unpaid compensation: Wages, bonuses, or commissions owed to an employee who dies before payment are IRD when paid to the estate or beneficiary.
- Installment sales: Payments due from installment sales retain their capital gain character as IRD when received after death.
- Dividend income: Dividends declared but unpaid at death, including those from funds like DIV, are IRD and taxable when received.
Important Considerations
IRD creates complex tax implications, so careful planning is essential. The dual taxation risk means you should coordinate estate and income tax strategies to minimize the overall tax burden.
Utilizing the IRD deduction effectively requires detailed calculations based on the estate tax paid on IRD amounts. Consulting with tax advisors and referencing concepts like ability to pay taxation can help optimize your approach and protect your beneficiaries from unnecessary taxes.
Final Words
Income in Respect of a Decedent can trigger significant tax consequences due to its dual inclusion in estate and income tax calculations. Review your situation with a tax professional to identify IRD items and plan strategies that minimize overall tax exposure.
Frequently Asked Questions
Income in Respect of a Decedent (IRD) is income that a person earned or was entitled to before their death but did not receive or report on their final tax return. This income is taxable to the estate or beneficiary when received and is also included in the decedent's estate for federal estate tax purposes.
Common examples of IRD include unpaid wages, accrued interest or dividends, deferred compensation, installment sale payments, retirement plan distributions like IRAs and pensions, and uncollected rent or alimony. Essentially, it covers income earned but not received before death.
IRD is included in the recipient’s gross income in the year it is received and retains its original character, such as ordinary income or capital gains. The estate reports IRD on Form 1041, while beneficiaries report it on their personal Form 1040.
IRD faces double taxation because it is included in the decedent’s gross estate for estate tax purposes and then taxed again as income when received by the estate or beneficiary. However, a special deduction under IRC Section 691(c) allows the recipient to deduct the portion of estate tax attributable to the IRD, reducing the overall tax burden.
For cash-basis decedents, IRD is reported by beneficiaries when actually received after death. For accrual-basis decedents, accrued income items are generally reported on the final return, except for certain items like qualified death benefits or deferred compensation which remain IRD.
Yes, a deceased S corporation shareholder’s pro rata share of accrued income is treated as IRD and taxed accordingly. However, the inherited S corporation stock itself receives a step-up in basis, which can help reduce capital gains tax if the stock is later sold.
IRD is reported in the year it is received by the estate or beneficiary. The estate reports IRD on Form 1041, while individual beneficiaries include it on their personal income tax return using Form 1040.
