Beware of IRD Issues When Receiving an Inheritance
Posted by Cheryl A. Jankowski on April 23, 2024
While inheritances are typically welcomed, they can sometimes present unexpected tax complexities. Notably, inherited property is often tax-free to the recipient, except in cases involving property classified as Income in Respect of a Decedent (IRD). Particularly, individuals with substantial balances in IRAs or other retirement accounts, or those inheriting such assets, may encounter significant estate planning challenges.
Understanding IRD
IRD refers to income that the deceased was entitled to but hadn't received before their death. While it's included in the deceased's estate for estate tax purposes, it isn't reported on their final income tax return, which only covers income received before death.
To prevent this income from evading taxation, the tax code mandates its taxation upon distribution to the deceased's beneficiaries. Furthermore, IRD maintains the same character it would have had in the deceased's hands. For instance, if the income would have been a long-term capital gain for the deceased, it's taxed as such to the beneficiary.
IRD can stem from various sources, including unpaid salary, fees, commissions, bonuses, distributions from retirement accounts, deferred compensation benefits, and accrued but unpaid interest, dividends, and rent.
Addressing the Issue
While IRD must be included in the recipient's income, a deduction may be available to mitigate the "double tax" impact resulting from both estate and income taxes. This deduction, typically claimed as an itemized deduction, aims to offset the tax burden arising from having IRD items subjected to both estate tax and the recipient's income tax.
Calculating the IRD deduction requires determining the net value of all IRD items in the decedent's estate, reduced by any deductions in respect of the decedent. This deduction helps alleviate the tax liability proportionate to the IRD items' contribution to the estate tax.
Given the complexity of calculating the deduction, especially with multiple IRD assets and beneficiaries involved, it's crucial to be prepared and seek professional guidance. Identifying IRD assets and understanding their tax implications can help recipients navigate potential tax surprises effectively.
As IRD assets pose unique challenges in estate planning, it's advisable to consult with us. Together, we can assess your situation, identify IRD assets, and devise appropriate strategies to manage their tax implications.
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Cheryl has extensive experience working with business owners and individuals on minimizing taxes, with a focus on succession planning. With a thoughtful approach, Cheryl helps clients explore their long-term goals and plan accordingly. Leveraging Cheryl’s expertise in this area, the goal is to implement plans that achieve the wishes of the client and provide for tax-efficient transitions. Cheryl’s passion for working with corporations and individuals has allowed her to become a trusted business advisor. She has worked with clients not only in the Western New York region but also throughout the country. The breadth of this experience has allowed her to collaborate with other professional advisors to ensure that plans are flexible and innovative in the ever-changing world in which we live. Cheryl started her career with the Firm in 1991 and rejoined in 2019 adding additional strength to the tremendous talent of the Lumsden McCormick tax team.