How income earned before death is taxed when received later

Income in respect of a decedent is often shortened to IRD. Start by identifying the accounting method, entitlement to payment and any amounts already reported. Then gather records showing who inherited the right, who collected it and whether anyone transferred or canceled it.

Research notice: Based on primary sources linked below. Core authorities include IRC §691 and the linked regulations, together with IRS Publication 559. Ask an estate attorney or CPA to confirm income classification, reporting, a proposed transfer or a deduction before acting.

How income in respect of a decedent works

IRD means gross income to which the decedent was entitled that was not properly includible on the final or an earlier return under the decedent's accounting method. Items excluded from gross income remain excluded.

The definition includes accrued income under the cash method, income accruing solely because of death under an accrual method and contingent income claims existing at death.

On receipt or a taxable transfer of an inherited IRD right, the income keeps the character it would have had if the decedent had lived and received it. Inheritance alone does not make every item ordinary income.

For a review, separate unpaid compensation, sale obligations, partnership payment rights, bonds and retirement accounts. Bring contracts and prior returns as well as the current asset list.

Unpaid employee compensation

Check the employment agreement, payment records and amounts made available before death. The compensation answer below explains how the final return review affects classification.

Sales completed before or after death

The regulation's orchard example assumes cash method accounting. The decedent completed a sale to one buyer before death. Gain from that sale is IRD when received.

The decedent also negotiated a separate sale to another buyer, but the executor completed that sale after death. Gain from the executor's sale is not IRD. Apply this distinction to the example's facts rather than to every pending sale.

Inherited installment obligations

Use the installment payment answer below when reviewing continued collections. Before selling, giving away, forgiving or restructuring an inherited note, bring the original sale documents, payment history and relationship information to the adviser.

Transfers of inherited income rights

An estate or successor generally recognizes income when it transfers an inherited IRD right. Inclusion occurs in the transfer year at the greater of consideration received or fair market value. A gift requires inclusion of fair market value.

Transmission at death is excluded from this transfer rule. Transfers pursuant to the recipient's entitlement by death, bequest, devise or inheritance are also excluded. For installment obligations, reduce inclusion by the decedent's obligation basis determined under §453B.

For an obligation arising from the decedent's installment method sale, transfer to the obligor triggers transfer treatment. Cancellation, including cancellation at death, also triggers that treatment. An obligation becoming unenforceable is treated as canceled.

For these installment obligation events, inclusion equals the greater of consideration received or fair market value, less the obligation's basis. Use the decedent's basis adjusted for installment payments received after death and before transfer.

If the decedent and obligor were related persons within §453(f)(1), fair market value cannot be less than face amount.

Partnership payments and investment review

Partnership payments under §736(a) to a deceased partner's estate or successor are IRD. Remaining §736(a) payments after a partner receiving those payments dies are included. Consideration from a third party for rights to future §736(a) payments is also IRD.

Separate §736(b) payments in exchange for the partner's interest in partnership property from those §736(a) payments. Section 736(b)'s exclusions for unrealized receivables and goodwill apply only when capital is not a material income producing factor and the deceased partner was a general partner.

Goodwill payments provided for in the partnership agreement are excepted from that goodwill exclusion. Take the partnership agreement, payment schedule and any goodwill allocation agreement to the review.

For detailed allocations and final distributive shares, use the business succession guide.

Qualified opportunity fund records

For qualified opportunity fund questions, review the specific regulation and statute in Sources with an adviser. Bring the investment date, deferred gain, proposed disposition and basis records, including records of any mixed investment.

Ask which statutory regime applies before making a transaction decision. For broader reading about private assets, see Private investments and real estate.

Estate tax deduction for IRD

A recipient including an amount under §691(a) may deduct the attributable federal estate tax after credits in the same year. Filing an estate tax return alone does not establish a §691(c) deduction.

First determine net IRD value by subtracting related expenses from the value of the IRD items. Compare actual federal estate tax after credits with the tax computed without that net value. The difference is the estate tax attributable to IRD.

Allocate that difference using a fraction. The numerator is the estate tax value of the IRD items included in the recipient's income, or the income included if lower. The denominator is the total estate tax value of all IRD items.

Estates and trusts exclude IRD passed out to beneficiaries from their own deduction computation. Individuals claim the deduction as an itemized deduction.

For §§1(h), 1202 and 1211, reduce capital gain IRD by its attributable deduction, but not below zero. Bring the estate tax return, supporting income valuations and related expense records to the deduction review.

Treasury and savings bond interest

Treasury bonds redeemable for estate taxes

Interest accrued but unreceived at death is IRD for U.S. Treasury bonds owned by a cash method decedent and redeemable for payment of federal estate taxes. This rule concerns those specific bonds.

If the estate redeems those bonds to pay federal estate taxes, it recognizes the interest in the year received. A successor entitled through death, bequest, devise or inheritance recognizes the accrued interest when received.

Interest accruing after death is taxable to its recipient but is not IRD.

Series EE and I savings bonds

For Series EE or I bonds bought entirely with a cash method decedent's personal funds, check whether the decedent reported interest annually. If not, the final return filer can elect to include all interest earned before death on that return.

Without that election, interest earned before death is IRD. A cash method successor who does not report interest annually may defer reporting until cashing or maturity, whichever comes first.

The interest reporting statement may include amounts already reported. Compare it with the decedent's returns and any final return election before preparing the recipient's return.

Who reports the income

For income meeting the definition above, the estate includes IRD in the year received if it acquired the right from the decedent. A person acquiring the right through death, bequest, devise or inheritance likewise includes it when received.

Distinguish direct collection from a distribution by an estate or trust. For revised §645 election filings and executor consent, consult the related reading link below.

Estate and trust distributions

The following distribution rules apply to estates and complex trusts subject to §661 rather than subpart B. Both the entity's deduction and the beneficiary's inclusion are subject to the exclusions described next.

Section 663(a) excludes qualifying gifts or bequests of a specific sum of money or specific property under the governing instrument. They must be properly paid or credited all at once or in no more than three installments.

An amount payable only from income is not a specific sum. Amounts paid, permanently set aside or otherwise qualifying for the §642(c) charitable deduction are also excluded.

Subject to those exclusions, §661 allows a deduction for income required to be distributed currently and other amounts properly paid, credited or required to be distributed. The deduction cannot exceed distributable net income, often shortened to DNI.

No deduction is allowed for the portion consisting of income excluded from the estate's or trust's gross income.

Under §662, beneficiaries include income required to be distributed currently, whether distributed or not. Other qualifying distributions are generally included up to DNI. When required distributions exceed DNI, beneficiaries take proportionate shares.

Amounts retain their character in the beneficiary's hands. Apply the §663(a) exclusions above to beneficiary inclusion as well as the entity's deduction.

Bring the governing instrument and distribution ledger to the fiduciary return review. Mark each payment's recipient, purpose and timing.

Related unpaid expenses

Expenses within §§162, 163, 164 and 212 may be deducted when paid if they were not properly allowable to the decedent for the final or an earlier period. The estate may claim these deductions.

A successor qualifies only if the estate is not liable for the obligation. The successor must have acquired the decedent's property subject to that obligation through death, bequest, devise or inheritance. These rules do not create a deduction for every inherited debt.

Inherited retirement accounts

A lump sum distribution from an inherited traditional IRA is taxable in the year received as IRD up to the decedent's taxable balance at death. That balance includes appreciation and accrued income through death, less nondeductible contribution basis.

Amounts exceeding the entire IRA balance at death, including taxable and nontaxable amounts, are beneficiary income. A surviving spouse's proper rollover into another traditional IRA is not currently taxed.

Qualified Roth distributions are excluded from income. A death distribution to a beneficiary or the owner's estate qualifies after the five tax year period beginning with the first tax year of a contribution to any Roth IRA of the owner.

For retirement payout deadlines, beneficiary categories and spouse elections, use the retirement accounts and beneficiaries guide. Gather beneficiary designations, account statements and contribution basis records.

Common questions