the Tax Deduction for Income in Respect of a Decedent
Debra H. Oden and Ben Sutherland
2005 - Understanding the tax deductibility of income in respect
of a decedent (IRD) is gaining significance as the baby boomer
generation reaches retirement. Many parents of the baby boomer
generation have accumulated significant wealth that will create
taxable estates. The following years will be critical, as
many individuals will become beneficiaries of estates that
include IRD, elevating the importance of the IRC section 691(c)
calculation of an individual’s gross estate upon death
includes all property the decedent owns or has an interest
in, and therefore would include any income owed to the decedent
at the time of death but not yet received. The fair market
value of IRD is included in the income tax return of the
beneficiary, whether an heir, an estate, or a trust (IRC
section 691). Because the inclusion in both the estate tax
return and the income tax return of the recipient can create
double taxation, the tax laws provide for a tax deduction
under IRC section 691(c).
deduction is allowed to the beneficiary of any IRD that
caused an increase in the estate tax of the decedent. The
deduction can reduce the added income tax the beneficiary
would bear as a result of including the IRD on its return.
Even though this is conceptually simple, taking the federal
estate tax deduction on IRD is often erroneously calculated
or missed entirely. Increased knowledge of what constitutes
IRD and how and when the deduction is taken, and recognition
of why it is a continued problem, can result in more-accurate
reporting and reduced taxes.
order to prevent the bunching of all income received after
a decedent’s death on the final income tax return,
Congress enacted IRC section 691, which essentially provides
for taxing the beneficiary on the postmortem income as it
is received. While there is no universal definition of IRD
found in the IRC, Treasury Regulations section 1.691(a-b)
provides a general guideline that IRD includes “those
amounts to which a decedent was entitled as gross income
but which were not properly includable in computing taxable
income for the taxable year ending with the date of his
death.” What constitutes IRD can vary depending on
the type of income received, the method of accounting used
by the decedent, and the date the income is actually received.
issues arise when the recipient of the IRD is subject to
the taxation on this income. According to IRC section 691,
the following parties may be subject to IRD from the following:
the estate of the decedent, if the right to receive the
income is acquired by the decedent’s estate from
the person who acquires the right to receive the income
by way of the decedent’s death, if the right to
the income is not acquired by the decedent’s estate
from the decedent; and
the person who acquires the right to receive the income
by bequest, devise, or inheritance, if the right to the
income is received through a distribution from the decedent’s
matter who the beneficiary is, the income, when received,
will be taxed to the beneficiary as it would have been taxed
to the decedent. Whenever a taxpayer dies, the beneficiary
of the property generally receives a step-up (or step-down)
in basis in the property equal to the fair market value
of the property on the decedent’s date of death (IRC
section 1014). Any increase in basis will help offset any
gross sale proceeds. As an exception, however, IRD is denied
this IRC section 1014 basis to prevent realized but unrecognized
income from evading its predetermined recognition by hiding
behind a taxpayer’s death. IRD does not receive a
step-up in basis, because the income has not been taxed
on the decedent’s individual income tax return, although
it is includible as an asset on the decedent’s estate
Ann, a decedent, was owed $500 in wages upon her death.
The beneficiary of these wages, Bob, will have the same
basis in the income as Ann did, in this case $0. Bob will
recognize the same amount of income as would have been recognized
by Ann, in this case all $500.
all IRD is included in the gross estate of a decedent, much
like all other decedent property, but it is also included
in the beneficiary’s income tax return when received,
to ensure proper taxation of the actual recipient. The IRD
beneficiary’s deduction comes in the form of a miscellaneous
itemized deduction not subject to the 2% of AGI floor equal
to the estate tax attributable to the net IRD [IRC section
That Constitutes IRD
determine whether an item of income is IRD, one must first
ascertain whether the income has been included on the decedent’s
individual income tax return. If it has not been subjected
to income tax, one must determine how it would have been
taxed to the decedent; a decedent’s income reported
by the beneficiary retains the same character it would have
had in the hands of the decedent [IRC section 691(a)(3);
Treasury Regulations section 1.691(a)-3]. The other consideration
is the accounting method used by the decedent. In general,
beneficiaries of cash-basis decedents must claim all IRD
when actually received unless the income was constructively
received on the decedent’s date of death. On the other
hand, the beneficiaries of an accrual-basis decedent must
claim only qualified death benefits and deferred compensation
owed to the decedent as IRD; other income, such as interest
and wages accrued on decedent’s date of death, would
be reported on an accrual basis on the decedent’s
final Form 1040.
examples of compensation owed to a beneficiary because of
a decedent’s death and treatment are as follows:
and salaries. Salary or wages earned by a
cash-basis decedent but unpaid as of his date of death constitute
IRD. Bonuses for services rendered payable to a cash-basis
decedent upon death are considered IRD if there was “substantial
certainty” the bonus would have been awarded, unless
paid directly to the recipient and thus considered a gift
[O’Daniel’s Estate v. Comm., 37 AFTR
1249 (1948)]. Fringe benefits are considered IRD unless
they would not have been included in the decedent’s
gross income, such as payments for permanent loss or disfigurement.
Postdeath payments to a third party are classified as IRD
even though the decedent was not entitled to them [Estate
of DiMarco v. Comm., 87 T.C. 653 (1986)].
income. Outstanding income owed to a self-employed
decedent (accounts receivable) is considered IRD but is
not subject to self-employment tax.
IRD includes interest accrued but not paid to a cash-basis
decedents do not consider accrued but unpaid interest as
IRD, but instead claim the revenue on their final 1040.
Decedents must be entitled to the dividend at death for
the dividend to be considered IRD. A decedent would be entitled
if the record date of the dividend precedes the decedent’s
date of death. If the record date is after the date of death,
dividends are considered ordinary income to the decedent’s
and royalties. Rents accrued on a day-to-day
basis since the last rental payment that remain unpaid on
a cash basis at the decedent’s date of death represent
IRD. Unpaid royalties attributable to predeath time periods
qualify for IRD treatment (Revenue Ruling 60-227, 1960-1CB262).
Barney, a cash-basis taxpayer, died on June 30. Upon his
death, Barney had accrued but not yet received $150 in interest
on bonds and $500 from a rental house. Barney’s beneficiary
will include $650 in IRD in his gross income when the interest
and rent are received.
proceeds. To be considered IRD, sales proceeds
must meet the following requirements [Reg. IRC section 1.691(a)-2(b)]:
The decedent entered into the contract for sale of the
property at hand;
The property must have been in a deliverable state upon
the decedent’s death (executor has only a passive
or administrative role in the sale);
No material contingencies would have disrupted the sale;
The decedent would have constructively or actually received
the sale proceeds if he had lived (the sale could have
been considered a receivable).
John, a self-employed car salesman, enters into a contract
to sell a car by agreeing to the buyer’s written offer.
John has full title to this car and the car is located on
his lot. John suddenly dies, before the buyer receives the
car and before John collects the proceeds. The executor
of John’s estate would be required to perform only
a passive role in the sale by collecting the proceeds and
handing over the keys to the car. The beneficiary of the
sale proceeds would therefore include the amount as IRD,
because John had contracted the sale, had placed the car
in deliverable state, had no material contingencies on the
car, and would have recorded the proceeds in gross income
had he lived.
dependent on a decedent’s death do not constitute
IRD, because the sale proceeds were not realized before
death [Treasury Regulations section 1.691(a)-2(b)].
property is still owned by the decedent at death, the beneficiaries
receive an IRC section 1014 stepped-up basis in the property
and no IRD. This is a valuable planning tool for individuals
looking to give property to someone else without the recipient’s
also receiving a large capital gain upon sale of the property.
compensation. Deferred compensation includes
payments received under such plans [e.g., 401(k)s and traditional
IRAs], whether or not the decedent was eligible to receive
the payments upon death (IRC sections 2031 and 2039).
compensation can either be monies payable to an employee
[defined for IRD purposes as amounts that an employee agrees
can be deducted from his earnings for payment at a later
date; amounts that are tax deferred; and amounts for which
the postponed payments have not been paid upon a decedent’s
death, as per Treasury Regulations IRC section 1.691(a)-2(b)]
or monies not payable to an employee, as well as monies
payable to an employee’s beneficiaries upon the employee’s
be excluded from IRD, the beneficiary must prove that the
compensation would not have been included in the decedent’s
gross income when received. For example, Roth IRA distributions
would not have been taxable to the decedent and thus are
not taxable to the beneficiary, because original contributions
to the plan were not tax deductible.
addition, retirement distributions that exceed the IRA owner’s
taxable IRA balance (the value at date of death, including
appreciation and accrued income less nondeductible contributions)
are not considered IRD (Revenue Ruling 92-47, 1992-1CB198).
John receives $500 per month in distributions from a traditional
IRA plan. John dies after receiving 10 distributions, while
the value of the account is $7,500, including unrealized
appreciation and accrued income and less nondeductible contributions.
John’s daughter, Sue, receives the right to the IRA
balance upon John’s death, and must include $7,500
of IRD in her gross income in each year she receives a distribution.
sale receipts. The recipient of an installment
obligation from a decedent would continue reporting the
receipt of payments just as the decedent had.
IRD portion of an installment sale payment should equal
the gross profit ratio multiplied by the annual payment,
plus any accrued interest of a cash-basis decedent not yet
received [IRC section 691(a)(4)].
Dan sells a piece of real estate he owns for $200,000. The
buyer promises to make 10 equal annual principal payments
of $20,000 for the next 10 years. Dan’s adjusted basis
in the property was $80,000 at the date of the sale. Therefore,
the gross profit ratio of this sale was 60% [($200,000 –
$80,000) ? $200,000], and 60% of each annual payment is
reported as a gain. Dan dies after receiving only two annual
$20,000 payments. The installment obligation becomes an
asset of Dan’s beneficiary, his estate; when it receives
the third annual payment, it would consequently report $12,000
in IRD. This reporting will continue if the note is passed
to a beneficiary. Any interest that was accrued and owed
to Dan upon his death would also be considered IRD; any
interest accruing after Dan’s date of death would
be classified as ordinary income.
Under IRC section 706, partnership income attributable to
the period before the decedent’s death should be included
in the partner’s final income tax return. All partnership
income attributable to postmortem periods will be included
in the income tax return of the successor (estate or beneficiary)
of the deceased partner’s partnership interest. Thus,
no IRD will be recognized by the successor no matter how
much distribution from the partnership is received by a
successor at a later date. In addition, IRD generally includes
unrealized receivables of a cash-basis partnership upon
the partner’s death that were later realized by the
partnership [IRC section 751(c)].
Nona, a 20% partner in calendar-year and cash-basis
N Partnership, died on June 19. Nona’s successor (her
estate) continued as the partner for the remainder of the
year. N Partnership’s income for the period ended
June 19 was $180,000, and unrealized receivables at Nona’s
death were $10,000. Nona’s share of this income ($36,000)
was reported on her final K-1 and subsequently on her final
income tax return. N Partnership’s income for the
remainder of the year was $210,000, and the unrealized receivables
were collected and realized. Nona’s
estate included its share of this income ($42,000) in its
gross income reported on its first estate income tax return.
At year-end, N Partnership distributed the entire year’s
proportionate share of income and collections ($78,000 of
income and $2,000 of postdeath realized receivables) to
Nona’s estate. Only $2,000 would be considered IRD,
because the other portion of the distribution had already
been reported in either Nona’s or the estate’s
corporations. An individual inheriting S corporation
stock from a decedent must treat the decedent’s pro
rata share of any IRD items (accrued but unpaid income items)
as IRD. S corporation stock received by a beneficiary would
receive an IRC section 1014 step-up in basis [Reg. IRC section
1.1367-1(j)]. The basis of S corporation stock that is acquired
from a decedent must be reduced by the value of the stock
that is attributable to the IRD items of the decedent related
to the S corporation [IRC section 1367(b)(4)(B)].
XYZ Inc., an S corporation, has 300 shares of stock outstanding.
John owns 75 shares, which are worth $100,000 at his date
of death. Also on this date, XYZ’s accrued but not
received income totaled $8,000. As a result, the beneficiary,
Sam’s basis in the 75 shares received from John is
stepped up to $100,000 (according to IRC section 1014),
then reduced by $2,000 (Sam’s share of IRD items).
In addition, Sam must report $2,000 of IRD on his income
in Respect to a Decedent
of accounting method, IRD is subject to income tax when
a triggering event, generally the actual receipt of the
income by the beneficiary, occurs. One way to initially
reduce the tax to the beneficiary is by claiming a deduction
in respect to decedent (DRD) to offset the revenue. The
IRS allows any recipient of current or future IRD to deduct
any properly allocable expenses against the income that
was properly not claimed on the decedent’s final return
[IRC section 691(b)]. Common DRD items include fiduciary
fees, commissions paid to dispose of assets, and state income
taxes. To be considered DRD, the expense must be paid by
the beneficiary that actually acquires an interest in the
property. DRD can be used to offset IRD on both the estate
tax return and the beneficiary’s income tax return,
just as IRD is taxed on both. DRD is treated similar to
IRD in that it must be deducted in the same manner as the
decedent would have taken the deduction.
Bob inherits property from Pam upon her death. This
property includes a parcel of real estate, and $5,000 in
gross wages payable to Pam upon her death. During the current
tax year, Bob collects the $5,000 in wages, less $1,000
in federal taxes and $500 in state taxes; he also pays $1,200
in property taxes on the real estate inherited. On Bob’s
current-year income tax return, he must claim the $5,000
in wages as IRD and include it in his gross income. Bob
may, however, deduct $500 of DRD for the state income taxes
withheld from Pam’s final paycheck. Bob may also deduct
$1,200 for the property taxes he paid, even though the real
estate did not generate any IRD. These DRD items will be
deducted in the same form as they would have been on Pam’s
of the Deduction
an estate is subject to federal estate tax and the gross
estate includes IRD, the beneficiary may claim all or part
of the federal estate tax deduction on its income tax return
[IRC section 691(c)]. The calculation of this deduction
varies depending upon the number of IRD items and IRD recipients.
No matter the intricacy of the computation, the goal remains
the same: 1) calculate the estate tax that qualifies for
the deduction, and 2) determine the IRD recipient’s
portion of the deductible tax.
to IRC section 691(c) and Treasury Regulations section 1.691(c)-1,
the federal estate tax deduction available to a beneficiary
is calculated as follows:
Establish the fair market value of all IRD items that
are included in the gross estate. This value may not be
what is ultimately collected by the beneficiary. Next,
determine the net value of the IRD by reducing the above
value by all related DRD, regardless of which beneficiary
claims the deductions [IRC section 691(c)(2(B)].
Calculate the net estate tax on the gross estate, including
the value of all IRD, and reduce it by any credits allowed.
Exclude the net value of all IRD, and recompute the net
estate tax. The difference between the two calculations
is the estate tax attributable to the inclusion of the
net IRD and is the total deduction available to all IRD
beneficiaries [IRC section 691(c)(2)(C)].
example for the calculation can be seen in the Exhibit.
deduction can be taken by the beneficiary as a miscellaneous
itemized deduction not subject to the 2%-of-AGI limit. However,
if more than one beneficiary receives IRD, or if IRD is
received by a single person in more than one year, an additional
computation must be made to determine each recipient’s
annual deduction. The appropriate allocation of the deduction
is calculated according to IRC section 691(c)(1)(A):
Divide the individual gross value of any IRD being included
in a beneficiary’s gross income by the total gross
value of all IRD being included in the gross estate of
the decedent. IRD should not be reduced by corresponding
DRD when making this calculation.
this fraction by the total federal estate tax deduction.
The result will be the allocable federal estate tax deduction
for each individual per year.
following examples show the effect of situations that include
multiple IRD recipients, including a surviving spouse, differences
in the value of IRD and the actual IRD received, and IRD
received over multiple years.
IRD recipients. David died, leaving three
children, Cory, Mark, and Joe. Upon David’s death,
Cory and Mark each inherited $10,000 in IRD items and Joe
inherited $5,000 in IRD items. Upon David’s death,
Cory was liable for an item of DRD valued at $1,000, making
the net IRD included in David’s gross estate $24,000.
Assume that when the calculation shown in the Exhibit is
done, the net estate tax attributable to the IRD items is
$9,900. The calculation of each child’s portion of
the $10,000 estate tax deduction is as follows:
and Mark’s Deduction
x $9,900 = $3,960
x $9,900 = $1,980
IRD recipients with a surviving spouse. Assume
Henry was survived by his wife, Cathy, and left IRD items
of $10,000 to her, $10,000 to his son William, and $5,000
to his daughter Anne. Because the $10,000 left to Cathy
qualifies for the marital deduction, it is excluded from
the gross estate when calculating the total estate tax deduction.
Assume the estate tax attributable to the inclusion of the
$15,000 in IRD in Henry’s gross estate is $6,200.
Cathy would then be entitled to an IRC section 691(c) deduction
of $2,480 [($6,200 x $10,000) ÷ $25,000], even though
her share of the IRD did not contribute to any estate tax,
because of the marital deduction (Revenue Ruling 67-242,
between the value of IRD and the actual amount received.
The value of an item of IRD upon the decedent’s
death is used to determine the maximum federal estate tax
deduction that an IRD recipient may claim, regardless of
how much IRD is actually collected. If the amount of IRD
actually collected is less than the determined value, the
available IRC section 691(c) deduction must be recalculated.
Assume that Steve inherits accrued but unpaid rent valued
at $9,000 from Brad, a cash-basis taxpayer. The estate tax
attributable to this rent, and thus the maximum IRC section
691(c) deduction, is $3,000. If,
however, Steve is able to collect only a third of the rent
($3,000), he is entitled to only a third of the federal
estate tax deduction ($1,000). Although Steve has lost a
$2,000 deduction, he does not pay income tax on the uncollected
rent of $6,000. An estate tax liability has already been
calculated on the $9,000 value of the IRD, however, resulting
in tax consequences.
received over multiple years. Goldie is bequeathed
an item of IRD valued at $10,000. The total IRC section
691(c) deduction related to this IRD is $3,000. Over the
next 10 years, Goldie collects $1,000 per year related to
this item of IRD. As a result, she is entitled to a federal
estate tax deduction of $300 ($3,000 x $1,000/$10,000) per
year to help offset the gross income included on her income
examples above show that any person who includes IRD in
gross income for the year is entitled to a portion of the
IRC section 691(c) deduction regardless of whether IRD contributed
to the estate tax and regardless of whether the amount of
the IRD collected was less than its value. In addition,
by not taking into account DRD items when computing each
individual’s annual deduction, individuals that are
not liable for the DRD do not receive any advantage from
its payment by the liable beneficiary.
is worth noting that each individual federal estate tax
deduction can be claimed only in the same year in which
the IRD is included in the recipient’s gross income.
For example, a beneficiary cannot record IRD in its gross
income in the year of the decedent’s death yet claim
the IRC section 691(c) deduction in the following year,
even if the estate was not settled until the second year.
Likewise, if IRD is received by a beneficiary in a tax year
following that of the decedent’s death, the federal
estate tax deduction will be taken in the year the income
is recognized, regardless of when the estate tax was actually
paid. In addition, a federal estate tax deduction may not
be fully deductible if the deduction results in the total
deductible Schedule A items exceeding the overall limit
on itemized deductions specified in IRC section 68. Finally,
an IRC section 691(c) deduction may not be fully used to
a beneficiary’s advantage if the beneficiary’s
total itemized deductions do not exceed the beneficiary’s
allowable standard deduction.
the obvious income tax benefits of the federal estate tax
deduction, the failure to recognize IRD and the deduction
can be problematic for several reasons. Often, different
tax advisors, CPAs, or attorneys prepare Forms 706, 1040,
and 1041 for all the parties involved. This alone may be
the primary reason behind miscalculated or lost deductions
for estate taxes attributable to IRD on a beneficiary’s
tax return. Erroneously computed deductions can also be
attributed to the scarce literature on the subject and the
fact that most tax software programs merely refer users
to IRS publications when calculating the deduction. Finally,
the IRC section 691(c) deduction can easily be miscalculated
when IRD is paid out over several years, making the computation
complex and ongoing.
H. Oden, JD, LLM (Tax), CPA, is an associate professor
at Missouri State University, Springfield, Mo.
Ben Sutherland, CPA, MAcc, is a staff accountant
at Whitlock, Selim & Keene LLP, Springfield, Mo.