Estate taxes are paid when the estate owner passes. But what about taxes on income received after death? This is where Income in Respect of a Decedent (IRD) comes in. This article will discuss calculating the IRD deduction and how it affects any beneficiaries.
Detailing the Income in Respect of a Decedent
Income in Respect of a Decedent (IRD) refers to income received after death in which taxes are owed. This income can be of many types, including:
- Uncollected salary, wages, bonuses, commissions, and vacation or sick pay
- Stock options exercised
- Taxable distributions from retirement accounts
- Distributions from deferred compensation
- Bank account interest
- Dividends, interest, and capital gains from investments
- IRAs and retirement plans
- Annuities
- Deferred compensation
- Installment payments
- Unpaid partnership liquidation distributions
- Royalties
In addition to estate assets, items of IRD are eventually distributed to beneficiaries. Most estate assets are transferred to beneficiaries tax-free. However, IRDs are taxed at the beneficiary’s regular ordinary tax rate.
Some estates pay federal taxes on IRDs, which allow beneficiaries to get an IRD tax deduction. The deduction amount is based on the amount of IRD taxes already paid.
IRDs are not subject to the 2% miscellaneous itemized deductions floor. An itemized deduction can only be taken against items that are more than the 2% floor. The floor is based on 2% of adjusted gross income (AGI). If a beneficiary makes $80,000 in AGI, their miscellaneous itemized deductions floor is 0.02 x 80,000 = $1,600.
Beneficiaries can determine if they'll receive an IRD deduction by looking at the decedent's estate tax return (IRS Form 706). If the decedent paid an estate tax for IRD items, beneficiaries could claim an IRD deduction. However, if no taxes were paid, then there won't be an IRD deduction available.
Income in Respect of a Decedent Examples
There is no step-up in basis for IRD items. The deduction only exists if taxes were already paid on IRD items. Let's look at an example to get a better idea of how the IRD deduction works.
The IRD deduction follows three steps:
- Calculate estate tax
- Recalculate estate tax and exclude IRD
- Calculate IRD tax deduction
The example will use an estate with a gross value of $15,000,000 and $1,000,000 in deductions. IRDs are $300,000. Note that it is exempt for 2022 if the estate is less than $12,060,000.
- Calculate estate tax
Gross estate: $15,000,000
Less deductions: -$1,000,000
Less exemption: -$12,060,000
Adjusted taxable estate: = $1,940,000
Estate tax from IRS: $776,000
Less unified credit: - $300,000
Total federal estate tax: = $476,000
- Recalculate estate tax and exclude IRD
Gross estate: $15,000,000
Less deductions: -$1,000,000
Less exemption: -$12,060,000
Adjusted taxable estate: = $1,640,000
Less IRD assets: -$300,000
Adjusted taxable estate without IRD: $1,340,000
Estate tax from IRS: $656,000
Less unified credit: - $300,000
Total federal estate tax: = $356,000
- Calculate IRD tax deduction
Federal estate tax: 476,000
Federal estate tax without IRD: -$356,000
Tax attributable to IRD: $120,000
If there is only one beneficiary, they’ll receive the full $120,000 tax deduction. If multiple beneficiaries are involved, they’ll receive a proportionate (however that may be determined) share of the $120,000 deduction.
The IRD deduction calculation may have only three steps, but it is tedious. That’s why working with a tax adviser is best when performing the calculation.
