Income in Respect of a Decedent: What It Is and How It’s Taxed

Income in Respect of a Decedent (IRD) is a critical consideration for beneficiaries managing the financial affairs of a deceased individual. It refers to income that was due to the decedent but not received before their death, and understanding its specifics is essential for tax planning.

Which Income Qualifies as IRD

IRD includes various types of income owed to an individual before their death but not received. This income retains its tax character and is taxable to the recipient, often the estate or beneficiaries. Examples include unpaid salary, wages, bonuses, or commissions earned but not yet paid. Interest accrued from savings accounts or bonds before death, such as interest on a certificate of deposit (CD) maturing after death, also qualifies as IRD. Dividends declared before death but paid afterward must be reported as IRD by the recipient.

Rental income is another example. If rent payments were made after the decedent’s death for a period including days before their passing, that portion is classified as IRD. Royalties from intellectual property or mineral rights that were due but unpaid at the time of death also fall under this category.

Determining Tax Liability

IRD is subject to both estate and income tax because it retains its tax characteristics and does not benefit from the step-up in basis typically applied to inherited assets. Tax rates depend on the recipient’s income tax bracket in the year the income is received. For instance, if a beneficiary is in the 24% tax bracket, the IRD they receive will be taxed at that rate. This additional income can potentially push beneficiaries into higher tax brackets, affecting deductions or credits.

The estate may also be liable for IRD taxes if the income is received before distribution to beneficiaries. Estates are taxed at graduated rates, with the top rate for 2024 being 37% for income over $13,450. Executors must strategically manage the timing and distribution of IRD to optimize tax outcomes for both the estate and beneficiaries.

Filing and Distribution Logistics

The executor or personal representative of the estate ensures that all necessary forms are accurately completed and submitted. Key to this process is preparing Form 1041, the U.S. Income Tax Return for Estates and Trusts, which is required if the estate’s gross income exceeds $600 in a tax year or if a beneficiary is a nonresident alien.

Decisions about distributing IRD directly to beneficiaries or retaining it within the estate depend on tax implications. Distributing IRD allows beneficiaries to report it on their individual tax returns, which may result in lower overall tax liability due to individual brackets. Executors must issue a Schedule K-1 to each beneficiary to detail their share of the estate’s income, deductions, and credits.

Timing is critical in managing IRD. Executors should carefully select the estate’s fiscal year, which can differ from the calendar year, to provide additional time for tax planning. Aligning the fiscal year with the decedent’s date of death can simplify administration. Filing deadlines for Form 1041, typically the 15th day of the fourth month following the end of the estate’s tax year, must be adhered to avoid penalties.

Coordination with Multiple Beneficiaries

Managing IRD distributions among multiple beneficiaries can be complex, requiring clear communication and strategic planning. Each beneficiary may have different financial situations and tax considerations. The executor must balance fairness with tax efficiency while adhering to the decedent’s will or trust. Detailed discussions with beneficiaries can help outline potential tax implications and distribution timelines.

Understanding relevant tax regulations, such as Internal Revenue Code (IRC) Section 691, is essential for minimizing the overall tax burden. For instance, spreading distributions over multiple tax years can prevent beneficiaries from being pushed into higher tax brackets. Discretionary distributions, if allowed by the will or trust, can be tailored to beneficiaries’ tax situations to further reduce liabilities.

Retirement Accounts and IRD

Retirement accounts often represent a significant portion of a decedent’s estate and carry unique considerations when classified as IRD. Traditional IRAs, 401(k)s, and other tax-deferred accounts are taxable to the recipient and do not benefit from a step-up in basis, meaning the entire distribution is subject to income tax. Beneficiaries must navigate these rules carefully to avoid excessive tax burdens.

The SECURE Act of 2019 introduced the “10-year rule,” requiring most non-spousal beneficiaries to withdraw the entire balance of inherited IRAs or 401(k)s within 10 years of the account owner’s death. This eliminates the option to stretch distributions over a beneficiary’s lifetime, increasing the potential for significant tax liabilities. For example, inheriting a $500,000 traditional IRA requires withdrawing and paying taxes on the full amount within a decade, which can create substantial tax challenges if not planned carefully. Spousal beneficiaries retain more flexibility, such as rolling the account into their own IRA or taking distributions based on their life expectancy.

Roth accounts, while also subject to the 10-year rule, differ in tax treatment. Since contributions to Roth IRAs are made with after-tax dollars, distributions are generally tax-free if the account has been open for at least five years. This makes Roth accounts advantageous for estate planning, as they pass to beneficiaries without the same income tax burden as traditional accounts. However, beneficiaries must still adhere to the 10-year distribution timeline to avoid penalties. Executors and beneficiaries must account for these distinctions to manage retirement accounts classified as IRD effectively.