Income in respect of a decedent ird

What Is Income in Respect of a Decedent (IRD)?

Income in Respect of a Decedent (IRD) refers to specific types of income that a deceased individual was entitled to receive but had not yet received at the time of their death. This unique category within tax law and estate planning ensures that certain earned income does not escape taxation merely because the owner passed away before collecting it. Unlike most inherited assets, which typically receive a step-up in basis and are not immediately subject to income tax upon receipt by the beneficiary, IRD is fully taxable to the recipient as gross income when it is received. Common examples of Income in Respect of a Decedent include unpaid salaries, deferred compensation, traditional IRA distributions, and accrued interest or dividends.

History and Origin

Before 1934, income that was earned by a cash-method taxpayer but not received prior to death would often escape income taxation entirely. To address this loophole and ensure equitable treatment between cash basis and accrual basis taxpayers, the law was amended to require the accrual of such income items on the decedent's final tax return. However, this led to an unintended consequence: a significant accumulation of income on the final return, potentially pushing the decedent into higher tax brackets.⁴⁸

Recognizing this issue, Congress enacted what is now Section 691 of the Internal Revenue Code in 1942.⁴⁷ This section established the concept of Income in Respect of a Decedent, shifting the tax liability for such income from the decedent's final income tax return to the estate or the designated beneficiary who actually receives the income. The intent was to tax this income when it is distributed to the deceased's beneficiaries, while also preserving its character for tax purposes.⁴⁶

Key Takeaways

• Income in Respect of a Decedent (IRD) is income earned by a deceased person but not collected before their death.
• IRD is subject to both estate tax at the decedent's death and income tax when received by the beneficiary.⁴⁴, ⁴⁵
• Recipients of IRD may be eligible for an itemized deductions for the federal estate tax paid on the IRD amount, mitigating some of the double taxation.³⁹, ⁴⁰, ⁴¹, ⁴², ⁴³
• The tax character of IRD remains the same for the recipient as it would have been for the decedent (e.g., capital gains or ordinary income).³⁸

Formula and Calculation

While there isn't a direct "formula" to calculate IRD itself, as it's a classification of income, there is a specific calculation for the Section 691(c) deduction, which helps offset the double taxation of IRD. This deduction allows the recipient of IRD to deduct the portion of federal estate tax attributable to the inclusion of the IRD in the decedent's taxable estate.

The deduction for estate tax attributable to IRD is calculated as follows:

Where:

• (\text{Net IRD Value}) = The total value of IRD items included in the decedent's estate, reduced by any deductions in respect of the decedent (DRD), which are expenses the decedent was entitled to deduct but had not paid before death.³⁷
• (\text{Federal Estate Tax Paid}) = The actual federal estate tax paid on the decedent's estate.
• (\text{Taxable Estate}) = The decedent's total taxable income for estate tax purposes.

The deduction is allowed as an itemized deduction for the beneficiary in the year the IRD is recognized.³⁶

Interpreting the Income in Respect of a Decedent (IRD)

Interpreting Income in Respect of a Decedent primarily involves understanding its tax implications for the recipient. When an estate or beneficiary receives IRD, that amount must be included in their gross income for the tax year in which it is received. This contrasts with most other inherited assets, which generally pass to heirs without immediate income tax consequences due to the step-up in basis rule.

The key interpretation is that the character of the income remains the same. For example, if the decedent was owed a bonus for work performed, that bonus is treated as ordinary income to the recipient. If the IRD originated from an installment sale that would have resulted in a capital gains for the decedent, the recipient will also report it as capital gains. This means the recipient might owe ordinary income tax, capital gains tax, or other types of income tax on the IRD, depending on its nature. Understanding this characteristic is crucial for proper tax return preparation and tax planning for the estate and its beneficiaries.

Hypothetical Example

Consider Sarah, who passed away on October 15. At the time of her death, she was owed $5,000 in uncollected salary from her employer, a $1,000 dividend that had been declared but not yet paid, and a $10,000 distribution from her traditional IRA that she was required to take for the year but had not yet withdrawn.

Upon her death, Sarah's daughter, Emily, is the sole beneficiary of her estate and her IRA.

1. Uncollected Salary: When Sarah's employer pays the $5,000 salary to Emily in November, this amount is considered Income in Respect of a Decedent. Emily must report the $5,000 as ordinary income on her personal income tax return for that year.
2. Unpaid Dividend: Similarly, the $1,000 dividend, once received by Emily in December, is also IRD. Emily will include this $1,000 as dividend income on her tax return.
3. IRA Distribution: The $10,000 required minimum distribution from Sarah's IRA, when distributed to Emily, is IRD. Emily must include this $10,000 as ordinary income on her tax return.

Assuming Sarah's estate paid federal estate tax, and the total net IRD was included in the estate, Emily may be able to claim a deduction for the portion of the federal estate tax attributable to these IRD items, reducing her overall income tax liability on these amounts.

Practical Applications

Income in Respect of a Decedent has several practical applications in personal finance, particularly in estate planning and taxation.

• Estate Administration: The executor of an estate must correctly identify and categorize IRD items. This is essential for proper tax reporting, as IRD is included in the decedent's estate for estate tax purposes but taxed as income to the recipient, rather than on the decedent's final tax return.³⁴, ³⁵ The IRS provides detailed guidance on handling income for survivors, executors, and administrators. [IRS Publication 559]
• Tax Planning for Beneficiaries: Beneficiaries receiving IRD need to be aware of their income tax obligations. This is especially critical for large amounts, such as distributions from retirement plans like traditional IRAs or 401(k)s, which are common sources of IRD.³³ Understanding the available deduction for estate taxes paid on IRD can significantly reduce the tax burden.³¹, ³²
• Charitable Giving: Individuals considering charitable bequests can strategically use IRD assets. Donating IRD assets to a charity can minimize the tax loss, as qualified charities are generally tax-exempt and would not owe income tax on the IRD, effectively avoiding both income and estate taxes on those assets.³⁰
• Avoiding Double Taxation: The Section 691(c) deductions for estate taxes paid on IRD is a crucial mechanism to mitigate the dual taxation effect where the same income is subject to both estate tax and income tax. Financial professionals often advise on how to maximize this deduction.²⁸, ²⁹

Limitations and Criticisms

While Income in Respect of a Decedent (IRD) serves to ensure certain income is taxed, the concept can lead to complexity and, at times, what is perceived as a significant tax burden.

One of the primary criticisms of IRD is the "double taxation" aspect. The same income is included in the decedent's estate for estate tax purposes and then taxed again as ordinary income to the beneficiary when received.²⁷ While Section 691(c) provides a deductions for the estate tax paid on the IRD, this deduction only partially mitigates the issue and does not fully eliminate the combined tax liability.²⁶ For example, the estate tax exemption, which has been significantly expanded in recent years, can still be a factor for very large estates.²⁵

Another limitation stems from the complexity of identifying what constitutes IRD. The Internal Revenue Code does not explicitly define IRD, relying instead on Treasury Regulations and court interpretations.²³, ²⁴ This can create ambiguity, especially with complex financial arrangements or incomplete transactions at the time of death, such as installment sales.²² This complexity often necessitates professional guidance from tax advisors and estate planners, as errors can lead to missed deductions or unexpected tax liabilities.²¹ The absence of a step-up in basis for IRD, unlike other inherited property, is also a notable point, meaning beneficiaries cannot reset the cost basis to the fair market value at the date of death.¹⁹, ²⁰

Income in Respect of a Decedent (IRD) vs. Inheritance

The terms Income in Respect of a Decedent (IRD) and inheritance are often confused, as both involve assets received after a person's death, but their tax treatments are fundamentally different.

The primary distinction is how they are treated for income tax purposes for the recipient. While most inherited property generally passes to heirs without immediate income tax consequences due to the step-up in basis, IRD explicitly retains its character and is subject to income tax when received by the beneficiary or estate.

FAQs

What types of income are considered Income in Respect of a Decedent (IRD)?

IRD can include various types of income that the decedent earned but did not receive before their death. Common examples are unpaid salaries, commissions, bonuses, accrued interest and dividends, deferred compensation, and distributions from retirement plans such as traditional IRAs and 401(k)s.⁹, ¹⁰ Gains from installment sales where payments are received after death also qualify.⁸

Who pays taxes on Income in Respect of a Decedent (IRD)?

The person or entity that receives the Income in Respect of a Decedent is responsible for paying the income tax on it. This is typically the decedent's estate or a designated beneficiary who acquires the right to receive the income.⁶, ⁷ The income is reported on their respective tax return in the year it is received.

Can you avoid taxes on Income in Respect of a Decedent (IRD)?

You cannot generally avoid income taxes on IRD, as the tax code is specifically designed to ensure this income is taxed. However, the law provides a deduction under Section 691(c) for the federal estate tax attributable to the IRD, which helps offset some of the tax burden.⁴, ⁵ Additionally, gifting IRD assets to a tax-exempt charity can be a strategy to avoid income tax on those specific assets.³

Does Income in Respect of a Decedent (IRD) get a step-up in basis?

No, Income in Respect of a Decedent (IRD) does not receive a step-up in basis. This is a key difference between IRD and most other inherited assets. While other inherited assets typically have their cost basis adjusted to the fair market value at the date of death, IRD retains the decedent's basis, and the full amount received is generally taxable income to the recipient.¹, ²