What is Income in Respect of a Decedent?
Income in respect of a decedent (IRD) refers to untaxed income that a decedent had earned or had a right to receive during his or her lifetime. IRD is taxed to the individual beneficiary or entity that inherits this income. However, IRD also counts toward the decedent’s estate for federal estate tax purposes, potentially drawing a double tax hit. Fortunately, the beneficiary may be able to take a tax deduction from estate tax paid on IRD. The beneficiary must declare IRD as income for the year in which the person received it.
Understanding Income in Respect of a Decedent (IRD)
Income in respect of a decedent is defined in I.R.C. section 691. Sources include uncollected salaries, wages, bonuses, commissions, vacation pay, sick pay, uncollected rent, retirement income, payments for crops, interest and dividends accrued, distributions from certain deferred compensation and stock option plans, accounts receivable of a sole proprietor, and gain from the sale of property if the sale is deemed to occur before death but proceeds are not collected until after death.
Income in respect of a decedent (IRD) refers to untaxed income that a decedent had earned or had a right to receive during his or her lifetime, and it is taxed both to the decedent’s estate for federal estate tax purposes and to the individual beneficiary or entity that inherits the income—creating the potential of a double tax hit in the case of any estate tax paid.
IRD will be taxed as if it was taxed upon the decedent if he or she were still alive. For example, capital gains would be taxed as capital gains and uncollected compensation would be taxed as ordinary income on the beneficiary’s tax return for the year he or she received it. There is no step-up in basis for IRDs.
How IRD Works for IRAs and 401(k)s
Other common examples of IRDs are distributions from tax-deferred qualified retirement plans such as 401(k)s and traditional individual retirement accounts (IRAs) that are passed on to the account holder’s beneficiary. If an individual dies leaving behind a $1 million IRA to his beneficiary, the inheritor will be responsible for paying taxes on any distributions made from the account.
The beneficiary usually would have to start taking required minimum distributions (RMD)s at a certain point. A living spouse who is the sole beneficiary has certain rights not granted to another type of beneficiary. For example, a spouse can roll over the decedent’s IRA assets into their own IRA and postpone RMDs until age 70½ . Either way, each beneficiary has specific RMD rules to follow and would be liable for applicable taxes.
If the decedent died on or after reaching age 70½ , their RMD for the year of death will factor into their estate. If this were to push the decedent’s estate beyond the federal exemption ($11.4 million in 2019), an estate tax of 40% will kick in.
To try to minimize this impact, individuals and married couples devise estate-planning strategies that involve transferring assets to trusts. One option is a credit shelter trust, which postpones estate taxes until the death of the surviving spouse.