Income in Respect of a Decedent (IRD) is a crucial accounting and legal concept that relates to untaxed income that an individual, who has passed away, earned or had a right to receive before their death. It is important to grasp the implications of IRD for both the beneficiaries and the estate itself, especially concerning taxation.
Key Takeaways
- Definition of IRD: Untaxed income earned by a decedent that beneficiaries must claim and pay taxes on.
- Tax Responsibilities: Beneficiaries, rather than the decedent's estate, are liable for taxes on IRD.
- Dual Taxation: IRD counts towards the decedent’s taxable estate, possibly leading to double taxation.
- Tax Deductions: Beneficiaries may be eligible for a tax deduction for estate taxes paid reliant on IRD.
What Constitutes IRD?
The definition of IRD is codified in Section 691 of the Internal Revenue Code. Typical sources of IRD include:
- Wages: Unpaid salaries and bonuses
- Benefits: Vacation and sick pay not received prior to death
- Rent: Uncollected rental income
- Retirement Distributions: Unwithdrawn amounts from retirement accounts, such as 401(k)s and IRAs
- Interest and Dividends: Accrued financial income not realized during the decedent's life
- Commissions and Sale Proceeds: From business transactions or sales not completed before death
The beneficiary of the decedent inherits these income rights and is responsible for reporting and paying taxes on them.
The Taxation of IRD
IRD is taxed following the same rules applicable to the decedent during their lifetime. Here are some examples of how it is treated:
- Ordinary Income: Unpaid salaries, self-employment income, or bonuses are taxed as ordinary income at the beneficiary's income tax rate.
- Capital Gains: If the IRD pertains to assets sold after death, but the sale was deemed to have occurred before death, capital gains would be taxed at the applicable capital gains rate.
Special Cases: IRAs and 401(k)s
For qualified retirement accounts such as IRAs and 401(k)s, the situation is distinctively structured. When the account holder passes away, the beneficiary may face the following considerations:
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Required Minimum Distributions (RMDs): Spouses and other beneficiaries must comply with RMD rules, which dictate the minimum amounts that must be withdrawn from retirement accounts annually. As highlighted in recent legislation (such as the SECURE Act), this age was raised to 73, affecting how long beneficiaries can defer taxes.
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Tax Liabilities: If a decedent owned a $1 million IRA, the heir becomes liable for taxes on any distributions from that account.
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Spousal Benefits: A surviving spouse may roll over the decedent's IRA into their own, allowing them to avoid immediate tax implications and defer RMDs until age 73.
Impact on Estates
When a decedent dies, any outstanding IRD may impact their estate significantly. If a decedent has uncollected amounts from the year of their death, these can elevate the overall value of the estate, potentially triggering estate taxes. As of 2024, the federal estate tax exclusion stands at $13.61 million. Implementing estate-planning strategies, such as creating trusts, can help mitigate the tax burdens from both IRD and other estate assets.
Reporting and Differences from Inheritance
Beneficiaries must report IRD on their income tax returns in the calendar year they receive it. Unlike typical inheritances, which may not incur tax owed (depending on the state), IRD is subject to income tax, making it essential for beneficiaries to differentiate between ordinary inheritance and IRD.
Reporting IRD
To properly report IRD, beneficiaries should:
- Recognize the forms of income owed to the decedent.
- Track and include IRD amounts as ordinary income on their tax returns.
- Understand any potential deductions for estate taxes related to the IRD if applicable.
Conclusion
Income in Respect of a Decedent (IRD) encompasses crucial financial responsibilities that heirs must navigate upon the loss of a loved one. While IRD offers opportunities for receiving untaxed income, it also brings complexity in taxation, particularly in connection with federal estate taxes. Beneficiaries should consult tax professionals to ensure they understand their responsibilities and maximize any applicable deductions to soften the financial implications of inheriting this income.