Income in respect of a decedent (IRD) denotes income that the deceased individual had earned or was entitled to but had not collected at their demise. This income is part of the decedent's estate but doesn't feature in their final income tax return.
IRD taxes are typically owed by the individual or entity inheriting this income. IRD contributes to the decedent's estate value for federal estate tax objectives, which might lead to double taxation. The good news is beneficiaries might be eligible to claim a tax deduction for the estate tax levied on IRD. Beneficiaries are required to declare the IRD as income for the year they receive it.
IRD covers unpaid income that the deceased individual had earned or was scheduled to receive while alive. This income is taxed as though the deceased is still alive. Beneficiaries are required to pay taxes on IRD income under most circumstances.
IRD can also be derived from sales commissions and individual retirement account (IRA) distributions that the decedent was entitled to at their death. It's taxed as if the decedent was still alive. For instance, capital gains are burdened with capital gains tax, and uncollected compensation is taxed as ordinary income on the beneficiary's tax return for the year of receipt.
Common examples of IRD include distributions from tax-deferred qualified retirement plans (like 401(k)s and traditional IRAs) that get passed on to a beneficiary. If a person dies, leaving a $1 million IRA to their beneficiary, the beneficiary is liable for paying taxes on any distributions made from the account in the year it was received.
A beneficiary of an inherited retirement plan may have to start taking required minimum distributions (RMDs) at a certain point. A surviving spouse, who is the sole beneficiary, has certain rights that other beneficiaries don't possess. For instance, a spouse can roll over the decedent's IRA assets into their own IRA and take Required Minimum Distributions (RMDs) once they are 73.
Additionally, a beneficiary has to follow specific RMD rules and is accountable for relevant taxes on distributions. The age for RMDs was increased to 72 with the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019. The SECURE 2.0 Act in December 2022 further raised the age to 73. If the decedent died after reaching the age of RMDs, their RMD for the death year might factor into their estate.
To reduce this impact, individuals and married couples can employ estate planning strategies, like credit shelter trusts, which delay estate taxes until the surviving spouse passes away.
If an heir receives such income, it will be reported on the personal income tax return for the year received. An inheritance is typically tax-free, but taxes will be due on the IRD income received. The tax will be determined on how the decedent would have been taxed. IRD income is taxed for the beneficiary who receives it. If the IRD incurs a tax liability for the decedent's estate, a beneficiary could potentially claim a deduction for estate taxes tied to the IRD value.