Understanding Income in Respect of a Decedent (IRD): What It Is and How It Affects Your Taxes
The passing of a loved one can bring about many emotional and financial challenges, one of which is managing the deceased’s financial affairs. Among the various aspects of settling an estate, understanding income in respect of a decedent (IRD) is crucial, as it has significant tax implications for both the decedent’s estate and the beneficiary. In this article, we discuss what IRD is, how it is taxed, the impact of IRD on retirement accounts, and why working with a fiduciary financial advisor can be beneficial.
What Is IRD?
Income in respect of a decedent refers to income the decedent was entitled to but had not received before their death. This income, which is still owed to the estate or the beneficiary, can be subject to estate taxes and income taxes. IRD can come in various forms, such as salary payments, commissions, bonuses, dividends, interest, and taxable distributions from retirement accounts.
Taxation of IRD
IRD is subject to a potential double tax hit. First, it is considered part of the decedent’s estate for federal estate tax purposes. If the estate’s value exceeds the federal tax exemption amount, the estate may be subject to taxes.
Second, IRD is also taxed to the beneficiary at their ordinary income tax rates. However, the beneficiary may be able to claim an income tax deduction for any federal estate tax paid on the IRD.
Impact of IRD on Retirement Accounts
IRD can significantly impact retirement accounts like 401(k)s and individual retirement accounts (IRAs). When a beneficiary inherits a retirement account, they generally must take required minimum distributions (RMDs). These RMDs are considered IRD and are subject to income tax at the beneficiary’s ordinary income tax rates.
Moreover, if the decedent’s estate is subject to federal estate tax, the retirement account’s value is included in the decedent’s gross estate, leading to the potential double tax hit mentioned earlier.
How IRD Is Taxed
IRD is generally taxed as ordinary income to the beneficiary, and the tax rate depends on the beneficiary’s tax bracket. However, some IRD items may be subject to different tax treatments, such as capital gains or qualified dividends.
When IRD comes in the form of RMDs from an inherited retirement account, the beneficiary is required to take distributions and pay taxes on the withdrawals at ordinary income tax rates.
Reporting IRD
A beneficiary should report IRD on their income tax return for the year they received it. The income is typically reported in the same manner as the decedent would have reported it.
For example, if the IRD consists of unpaid salary, it should be reported as wages on the beneficiary’s tax return. The beneficiary may need to complete other forms, such as Schedule B for interest and dividends or Schedule E for rental income, royalties, or partnership income.
Working with a Fiduciary Financial Advisor
IRD can complicate your finances and tax situation, especially if you are unfamiliar with the nuances of estate and income tax laws.
Working with a fiduciary financial advisor could be beneficial in navigating the complexities of IRD. A fiduciary financial advisor is obligated to act in your best interest when providing you with advice on managing inherited assets and minimizing the tax burden associated with IRD.
For example, our fiduciary retirement planning firm helps clients plan for IRD in various areas:
Tax planning: We develop tax-efficient strategies to help minimize the impact of IRD on a client’s overall tax liability.
Retirement planning: For those inheriting a retirement account, we help them understand their options for managing the account, such as taking RMDs, implementing qualified charitable distributions (if over 70 ½), and/or converting to a Roth IRA, which is available for only a spousal beneficiary.
Estate planning: We provide guidance on estate planning strategies so a client’s estate is structured optimally to minimize tax liabilities and provide for loved ones.
Final Thoughts
Understanding income in respect of a decedent and its impact is essential when planning an estate strategy or managing the financial affairs of a deceased loved one. IRD can result in a double tax hit, with implications for both the decedent’s estate and the beneficiary inheriting the income.
As IRD can complicate your financial and tax situation, you might find working with a fiduciary financial advisor beneficial. Their expertise could help you navigate the complexities of IRD and minimize its tax burden.
We offer a complimentary 15-minute call to discuss your financial situation and concerns and share how we may be able to help.
This material was generated using artificial intelligence (ChatGPT) and edited by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
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