What it means
Income in respect of a decedent, or IRD, is money that a person had a right to receive at death but that had not yet been counted as their taxable income. Common examples include the balance of a traditional IRA or 401(k), unpaid salary or commissions, accrued but unpaid interest and deferred compensation.
The person who receives the money after death must usually report it as income when it is paid. If the deceased person's estate was large enough to owe federal estate tax, the same asset was taxed once through the estate and is taxed again as income to the beneficiary.
The tax code offers relief through the IRD deduction, found in section 691(c) of the Internal Revenue Code. It allows the beneficiary to deduct the portion of estate tax that is attributable to the IRD.
The amount is found by comparing two figures: the estate tax actually paid and the estate tax that would have been paid if the IRD items had not been included in the estate. The difference is the estate tax attributable to the IRD.
The beneficiary claims it as the IRD is received, so a person who takes a share of an inherited retirement account in a year claims a matching share of the deduction. The deduction is claimed as an itemised deduction on the beneficiary's income tax return and is not limited by the 2% of adjusted gross income floor that applies to some other itemised items.
Because it is itemised, it matters most to people who would otherwise itemise anyway, and it is claimed separately from the standard deduction. Records should show the calculation and the estate tax return.
The deduction matters only when the estate actually paid federal estate tax, which is relatively rare because the exemption is set high and changes over time. When it does apply, the amounts can be large, so executors and advisers should compute it early.
The rules are technical, and a tax professional is usually needed to prepare the figures.
In practice
Real-world examples.
Example
A widower leaves his daughter a traditional IRA worth $1,000,000, and his large estate owes federal estate tax. As she withdraws money each year, she reports the withdrawals as income and claims a matching share of the IRD deduction, which softens the tax bill.
Example
A consultant dies before being paid $60,000 for completed work. His estate collects the fee and includes it in his taxable estate. The beneficiary who receives the payment treats it as IRD and deducts the estate tax attributable to it, if any was due.
Example
An executor reviews the tax position of a large estate and notices that most of the value sits in a deferred compensation plan. She calculates the estate tax on those items separately so that the heirs can claim the correct deduction in future years.
Formula
Calculation
Deduction for the year = estate tax attributable to the IRD x (IRD included in income this year / total IRD in the estate)
An estate paid $400,000 of federal estate tax. Without the IRD items the tax would have been $320,000, so the estate tax attributable to the IRD is 400,000 - 320,000 = $80,000. The estate held $200,000 of IRD in a traditional IRA, and the beneficiary receives $50,000 of it this year. The deduction is 80,000 x (50,000 / 200,000) = 80,000 x 0.25 = $20,000. She reports the $50,000 as income and deducts $20,000 as an itemised deduction.Case study
Seen in the real world.
Ashworth Estate is an illustrative, fictional estate in which the deceased owner left a $3,000,000 traditional IRA, a house and other assets. The federal estate tax return showed total tax of $1,200,000, and a calculation without the IRA showed that tax would have been $720,000.
The estate tax attributable to the IRA was 1,200,000 - 720,000 = $480,000, which is 16% of the $3,000,000 balance. When the son withdrew $300,000 in the first year, he claimed an IRD deduction of 480,000 x (300,000 / 3,000,000) = $48,000.
The illustrative lesson is that the deduction is spread over the years in which the income is received, and keeping the original calculation on file saves a great deal of effort later.
Watch out
Common mistakes.
- Assuming every inherited account qualifies for the deduction, when it only applies if federal estate tax was actually paid.
- Deducting the whole estate tax in one year, when the deduction is limited to the part attributable to the IRD received in that year.
- Confusing it with a stepped-up basis, when IRD items generally do not receive one and are taxed as income when received.
Questions
People also ask.
What counts as income in respect of a decedent?
Income the deceased had earned or had a right to receive but that had not yet been taxed, such as retirement account balances, unpaid wages and accrued interest.
Where is the deduction claimed?
It is an itemised deduction on the beneficiary's income tax return, using the calculation based on the estate tax return.
Does a small estate need to worry about it?
Usually not, because most estates owe no federal estate tax, and without estate tax there is nothing to deduct.
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