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The topic of Income in Respect of a Decedent (IRD) can be a particularly confusing aspect of the tax code – but it doesn’t need to be. Put simply, IRD is any income that a decedent (the person who died) would have received had death not occurred – that has NOT been included as income on the individual’s final tax return. In essence, this rule provides that certain items in the estate, specifically income items, do not receive a step-up in basis. This income has to be accounted for on one of three tax returns:
- estate
- beneficiary’s income tax return (whoever received the income)
- other assignee of right to the income besides a beneficiary
If you are the beneficiary of an IRA and are required to include some IRD on your tax return, you may be eligible for a special IRD deduction. This deduction is limited to any estate tax that was paid on the income received in respect of the decedent. This would have to be a significantly-sized estate, since the applicable exclusion amount for 2019 is $11.4MM.
It is important to note that the IRD deduction is only available for federal estate tax – your state estate tax may or may not be deductible, you’ll need to check that with your state authorities.
IRD from an IRA
From an IRA, IRD includes any income that you receive that was included in the gross estate. Any growth that occurs after the date of death of the original owner becomes income to the beneficiary, and therefore is not IRD. Any estate tax that can be attributed to that IRD is deductible as a miscellaneous deduction on Schedule A of Form 1040 – this deduction is NOT one of the miscellaneous deductions that was eliminated with TCJA 2017. If the IRA had basis – that is, if the IRA included non-deductible contributions – then those contributions are not taxed to the beneficiary as IRD. Income tax has already been assessed on these amounts prior to contribution.
Roth IRA Nuances
For a Roth IRA, the IRD only includes income received via non-qualified distributions, and then only the portion that represents growth in the account. The main way that you could get caught by this one is if the IRA has not been established for the required five-year period prior to the death of the original owner. Any income (growth) in the account up to the date of death is IRD, the contributions are tax-free, and any growth after the date of death is income to the beneficiary (and not IRD).
IRD Deduction
To calculate the IRD deduction, you need to know the amount of the taxable estate, the amount of tax paid on the estate, and the value of the IRD item(s) in the estate. As an example, we’ll say we have an estate valued at $15MM, and an IRA worth $1MM. On the entire estate, we paid tax of $1,440,000 (40%).
Next, we calculate the estate tax on the value of the taxable estate without the value of the IRA – and we come up with $1,040,000. So the estate tax attributable to IRD is $400,000, or 40% of the IRA value. So, as distributions are made from the IRA, you can claim a deduction of 40% of each distribution until the entire $400,000 attributed estate tax is used up. This deduction offsets (in theory) the fact that you must include the distribution as ordinary taxable income.
Once again, this is not an activity for the faint of heart. I suggest working closely with your tax pro to make sure that you’re calculating things correctly – it can amount to some sizeable tax issues if you’ve fouled it up somehow.