Are Federal Estate Taxes Deductible?
Explore the specific circumstances where taxes paid by an estate can create a deduction, either for the estate itself or for a beneficiary's income tax.
The deductibility of federal estate taxes depends on the context. For an individual or an estate’s income tax return, federal estate taxes are not deductible in the same way as property or state income taxes, as the tax code does not provide a direct deduction. Instead, deductibility related to estate taxes emerges in specific, indirect ways. These rules exist to prevent the same funds from being taxed multiple times under different tax laws.
Allowable Deductions on a Federal Estate Tax Return
When an executor prepares a federal estate tax return, Form 706, the goal is to calculate the taxable estate by subtracting allowable deductions from the gross estate. The federal estate tax itself cannot be deducted on this return; the deductions are for expenses and transfers that reduce the estate’s value subject to tax.
Major deductions on Form 706 include the marital and charitable deductions. The unlimited marital deduction allows for the tax-free transfer of assets to a surviving spouse, while the charitable deduction applies to any portion of the estate left to a qualified charity. These can significantly lower or eliminate the federal estate tax.
The return also allows for deducting various expenses and debts. These include funeral expenses, administrative costs like executor and attorney fees, and debts the decedent owed at death, such as mortgages or credit card balances.
Another deduction is for state death taxes. Any state-level estate or inheritance taxes the estate pays can be deducted on the federal return. This prevents the federal government from taxing the portion of the estate used to pay state taxes. The executor must have paid these state taxes before claiming the deduction.
Understanding the Income in Respect of a Decedent Deduction
The most common scenario where a beneficiary encounters a deduction related to federal estate taxes involves “Income in Respect of a Decedent,” or IRD. IRD is gross income a deceased person was entitled to but had not received before death and was therefore not included on their final personal income tax return. Common examples include distributions from traditional IRAs and 401(k)s, unpaid salary, and payments from an installment sale.
The purpose of the IRD deduction is to mitigate double taxation, as an IRD asset is subject to two different taxes. First, its value is included in the decedent’s gross estate to calculate federal estate tax on Form 706. Second, when the beneficiary receives the income, they must report it on their own income tax return.
To alleviate this, the tax code allows the person who receives the IRD to take an income tax deduction for the portion of the federal estate tax that was paid on that specific asset. This deduction is for the federal estate tax attributable to the IRD, not for the IRD amount itself. The right to claim this deduction falls to the beneficiary who inherits the IRD, whether an individual, a trust, or the estate.
How to Claim the IRD Deduction on an Income Tax Return
A beneficiary who receives IRD from an estate that paid federal estate tax can claim the associated deduction on their personal income tax return, Form 1040. It is reported as a miscellaneous itemized deduction on Schedule A under “Other Miscellaneous Deductions” and should be labeled “Estate Tax Deduction” or “IRD Deduction.”
The IRD deduction remains available while most other miscellaneous itemized deductions are suspended through 2025. Taxpayers must itemize to claim this deduction; it cannot be claimed if taking the standard deduction.
Calculating the deduction requires information from the estate’s Form 706. The calculation determines the federal estate tax attributable to the net value of all IRD items by hypothetically re-calculating the estate tax without those assets included. The difference between the actual estate tax paid and this hypothetical lower amount is the total IRD deduction available to be allocated.
The estate’s executor is responsible for providing beneficiaries with the necessary information for this calculation, such as the total federal estate tax paid and the value of the specific IRD item received. If a beneficiary receives only a portion of the total IRD, they are entitled to a proportional share of the deduction. For example, a beneficiary who received 25% of the estate’s IRD assets could claim 25% of the total IRD deduction.