What it means
IRD comes from Internal Revenue Code Section 691. The core idea is that income tax follows the income to whoever ends up receiving it, since the decedent never had the chance to be taxed on it.
Typical IRD includes uncollected wages, bonuses, commissions, vacation and sick pay, rent owed to the decedent, accounts receivable of a sole proprietor, accrued interest and dividends, and certain deferred compensation or stock option payments. Retirement accounts are the big one in practice.
Distributions from traditional IRAs and 401(k)s passed to a beneficiary are IRD, and the beneficiary pays ordinary income tax as the money comes out. IRD is taxed the way it would have been taxed to the decedent.
Capital gains keep capital gains treatment, compensation stays ordinary income, and there is no step-up in basis for IRD items. A double exposure can arise.
IRD also counts inside the decedent's gross estate for estate tax, so large estates can see the same dollars hit by estate tax and then income tax. The law softens that overlap.
The beneficiary may claim an income tax deduction for the estate tax attributable to the IRD, which partial relief requires computing, not assuming. IRD is reported in the year received.
The beneficiary declares it as income when the money actually arrives, not at the date of death. The practical work is identification.
Executors and beneficiaries need to separate IRD items, which carry a tax bill, from ordinary inherited assets, which generally pass income-tax-free with a stepped-up basis.
In practice
Real-world examples.
Example
A retired executive dies mid-quarter with an unpaid bonus and accrued vacation pay. The estate collects both after the death. The amounts are taxed as ordinary income to the recipient, exactly as they would have been to the executive.
Example
A daughter inherits her mother's traditional IRA. Each distribution she takes is IRD taxed as ordinary income to her, on top of her own salary. She plans the size of each withdrawal against her bracket instead of taking one large sum.
Example
A sole proprietor dies with unpaid client invoices. When the estate collects the receivables, that income is IRD and taxable to whoever receives it. The family's accountant separates these receipts from the proprietor's other inherited assets, which carry a stepped-up basis.
Formula
Calculation
A simplified illustration: a beneficiary inherits a traditional IRA worth $500,000 and withdraws $50,000 this year.
That $50,000 is IRD and stacks onto the beneficiary's other income. At a 24% marginal rate, the federal income tax on the withdrawal is about $12,000 ($50,000 x 24%).
If the estate also paid estate tax on the IRA's value, the beneficiary may deduct the estate tax attributable to the IRD, in proportion to the IRD included in income each year. Suppose, purely for illustration, that $100,000 of estate tax is attributable to the IRA. The $50,000 withdrawal is 10% of the $500,000 of IRD ($50,000 / $500,000), so the deduction this year is $10,000 ($100,000 x 10%), claimed as an itemised deduction. At the same 24% rate, that saves about $2,400, cutting the net tax to roughly $9,600 ($12,000 - $2,400).
The exact deduction needs the estate's figures, so beneficiaries should coordinate with the executor before filing.Case study
Seen in the real world.
The following is an illustrative and fictional case. When Tomas Herrera died, he left his daughter Camila his traditional IRA and a final month of uncollected consulting invoices. Camila assumed inheritances were tax-free and nearly withdrew the whole IRA to renovate her home. Her accountant stopped her in time. He explained that every IRA withdrawal would land on top of her salary as ordinary income, and that the collected invoices were IRD too.
A full withdrawal would have pushed her into a much higher bracket for the year. They mapped a schedule instead: smaller annual distributions sized to her bracket, while confirming whether the estate had paid estate tax that could support a deduction. Camila still renovated, a year later and in stages. The taxes were significant either way, but spreading the income kept her bracket steady and the surprise out of her filing season.
Watch out
Common mistakes.
- Assuming inherited income is tax-free. IRD is taxable to the recipient as if the decedent had received it.
- Taking large retirement-account distributions in one year. Stacking IRD on top of regular income can push the beneficiary into a higher bracket.
- Missing the estate tax deduction. Beneficiaries may deduct estate tax paid on IRD, but only if they coordinate with the executor and claim it.
Questions
People also ask.
What are common examples of IRD?
Uncollected salary, bonuses, commissions, rent owed, accounts receivable, accrued interest and dividends, certain deferred compensation, and distributions from traditional IRAs and 401(k)s.
Is IRD taxed like an inheritance?
No. Ordinary inherited assets usually pass income-tax-free with a stepped-up basis; IRD is taxed to the recipient with no step-up.
Can the double taxation be reduced?
Partly. The beneficiary may deduct the estate tax attributable to the IRD, which requires the estate tax figures.
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