You may think of inheritances as tax-free. But in some cases—such as traditional individual retirement accounts—your inheritance includes what’s called “income in respect of a decedent.” That means you’ll generally have to pay income tax on your personal return even if the account balance was taxed on the estate return.
Income in respect of a decedent refers to amounts that would have been taxable income to the decedent because that person had the right to receive it. In the case of a traditional IRA, those amounts are the taxable portion of distributions that would have been taken from the account.
In T.C. Memo. 2015-82 (Morris), the taxpayer was the personal representative of his father’s estate, as well as the primary and sole beneficiary of his father’s traditional IRA. The paralegal of the attorney the taxpayer hired to settle the estate told the taxpayer he would not owe tax on the IRA, which had a balance of $96,442.
Per the taxpayer’s request, the IRA trustee issued a check for the balance of the account and did not withhold any federal income tax. The taxpayer distributed $37,000 of the account balance to two of his siblings. After the end of the year, the taxpayer received Form 1099 from the IRA trustee, but did not report the distribution of the IRA on his individual tax return.
The IRS said the distribution was taxable income.
The taxpayer argued that he did not “solely owe the tax debt and should not be held solely responsible for it.” He felt it would be inequitable to hold him solely liable for the tax because he voluntarily shared the proceeds with his siblings, from whom he was unlikely to recover anything. He also said he was disadvantaged by what he believed to have been erroneous advice from the law firm that assisted him in settling his father’s estate.
The court said that while the taxpayer acted honorably, his good conduct had no bearing on whether the IRA distributions were includible in his gross income, and that while the advice he thought he received from the law firm might have affected his liability for the accuracy-related penalty, it was irrelevant in determining the taxable status of the distributions themselves.
What would you decide in the following situations?
At the date of his death, a taxpayer was entitled to a large salary payment to be made in equal annual installments over five years. His estate, after collecting two installments, distributed the right to the remaining installment payments to the residuary beneficiary.
Who reports the income?
A widow acquired, by bequest from her husband, the right to receive renewal commissions on life insurance sold by him in his lifetime. The commissions were payable over a period of years. The widow died before receiving all of the commissions and her son inherited the right to receive the rest of the commissions.
Does the son have income in respect of a decedent?
The taxpayer owned a Series E US savings bond, with his wife as co-owner or beneficiary. He died before the payment of the bond.
How much should the wife report as income in respect of a decedent?
A taxpayer acquired 10,000 shares of corporate stock at $100 per share. During her lifetime, the taxpayer had entered into an agreement with the issuing corporation. Under the agreement, the corporation agreed to purchase (and the taxpayer agreed her executor would sell) the stock owned by her at the book value of the stock at the date of the taxpayer’s death.
Upon the taxpayer’s death, the stock is sold by the taxpayer’s executor for $500 a share pursuant to the agreement.
Is the appreciation of the stock considered income in respect of a decedent?
A taxpayer owned and operated an apple orchard. During her lifetime, she sold and delivered 1,000 bushels of apples to a canning factory. She did not receive payment before her death.
She also entered into negotiations to sell 3,000 bushels of apples to a second canning factory, but did not complete the sale before her death.
After the taxpayer’s death, the executor of her estate received payment from the first canning factory.
He also completed the sale to the second canning factory and transferred 1,200 bushels of apples on hand at the taxpayer’s death. He later harvested and transferred an additional 1,800 bushels.
Which sale constitutes income in respect of a decedent?
A taxpayer delivered 1,200 bushels of harvested apples to a cooperative association for processing and sale. Each year the association commingles the fruit received from all of its members into a pool and assigns to each member a percentage interest in the pool based on the fruit delivered by him.
After the fruit is processed and the products are sold, the association distributes the net proceeds from the pool to its members in proportion to their interests in the pool.
After the taxpayer’s death, the association made distributions to his estate’s executor with respect to the taxpayer’s share of the proceeds from the pool in which he had an interest.
Are the proceeds income in respect of a decedent?
Source of examples: Treasury Regulation 1.691(a)-2
This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.
The estate must include in its gross income the two installments received by it, and the beneficiary must include in his gross income each of the three installments received by him.
The commissions received by the widow were includible in her gross income. The commissions received by the son were not includible in the widow’s gross income but must be included in the gross income of the son.
The entire amount of interest accruing on the bond and not includible in income by the decedent, not just the amount accruing after the death of the decedent, would be treated as income to his wife when the bond is paid.
Since the sale of stock is consummated after the taxpayer’s death, there is no income in respect of a decedent with respect to the appreciation in the stock value to the date of her death.
If, in this example, the taxpayer had in fact sold the stock during her lifetime but payment had not been received before her death, any gain on the sale would constitute income in respect of a decedent when the proceeds were received.
The gain from the sale of apples by the taxpayer to the first canning factory constitutes income in respect of a decedent when received.
On the other hand, the gain from the sale of apples by the executor to the second canning factory does not.
Under such circumstances, the proceeds from the disposition of the 1,200 bushels of apples constitute income in respect of a decedent.