Income in Respect of a Decedent (IRC 691)

Inheritance is generally tax-free to the person who receives it. And under IRC 1014, most inherited property gets a new basis equal to its value at death. Sell Dad's stock a week after the funeral and there is usually little or no gain.

Then there is income in respect of a decedent, or IRD. IRD is income the decedent earned or had a right to, but had not yet received or reported, when they died. It does not get a new basis. It does not escape income tax. It just changes taxpayers.

The basic rule

IRC 691(a)(1) says that income in respect of a decedent is included in the gross income, for the year received, of whoever receives it:

• The estate, if the estate acquires the right to it.
• A beneficiary, if the right passes directly to that person by reason of death, such as through a beneficiary designation.
• A person who later receives the right from the estate, such as a beneficiary who receives it in a distribution.

IRC 691(a)(3) adds that the income keeps the character it would have had in the decedent's hands. Wages stay ordinary income. A capital gain on an installment note stays a capital gain.

And IRC 1014(c) slams the door on the step-up: the basis rules for inherited property do not apply to property that constitutes a right to receive IRD. That is the whole point. Income that would have been taxed to the decedent is taxed to someone.

Common examples

• Wages and bonuses earned before death but paid after.
• Traditional IRAs, 401(k)s and 403(b)s. Pre-tax money that was never taxed. Distributions to beneficiaries are IRD.
• Deferred compensation and nonqualified plan payouts.
• Installment sale notes. If the decedent sold property on installments and was reporting gain as payments came in, the remaining gain on the note is IRD.
• Accounts receivable of a cash-basis business or professional. A doctor's or consultant's unpaid invoices at death.
• Accrued interest on U.S. savings bonds that the decedent had deferred and not reported.
• Renewal commissions of an insurance agent paid after death.

For a Sarasota retiree, the largest IRD item by far is usually the IRA. A $600,000 traditional IRA can pass to children by beneficiary designation entirely outside probate and still carry hundreds of thousands of dollars of embedded income tax. The rules on how fast an inherited IRA must be distributed are their own topic; for this page, the point is simply that every pre-tax dollar is taxed when it comes out.

IRD is not on the final return

A common mistake is reporting IRD on the decedent's final Form 1040. The final return covers income actually or constructively received through the date of death. Amounts received after death go to the estate's Form 1041 or the beneficiary's own return.

Payers do not always cooperate. An employer may issue a W-2 for the whole year under the decedent's Social Security number, even though the last paycheck went to the estate. A brokerage may report interest under the decedent's number after death. When the forms are wrong, you report the right way and attach an explanation, or the IRS's matching program will flag the difference. The guide to beneficiary K-1 problems and IRS notices covers how those mismatches play out.

Deductions in respect of a decedent

The rule runs both ways. Under IRC 691(b), certain expenses the decedent owed but had not paid at death, such as business expenses, interest, and taxes, are deductible by the estate or the person who pays them, when paid. Those are deductions in respect of a decedent. A property tax bill paid by the estate after death is a common example.

The 691(c) deduction: relief from double tax

IRD can be hit twice. It is included in the gross estate at its full value for estate tax purposes. Then it is subject to income tax when received. For an estate large enough to pay federal estate tax, that stacks two taxes on the same dollars.

IRC 691(c) softens that. The person who includes IRD in income gets an income tax deduction for the federal estate tax attributable to that IRD. The computation compares the estate tax actually paid with the estate tax that would have been paid without the net IRD, and allocates the difference across the IRD items as they are received.

Three practical points:

1. It only applies when the estate actually paid federal estate tax. With a 2026 basic exclusion amount of $15,000,000, most estates owe none, and the deduction is zero.
2. The beneficiary needs information from the executor to compute it: the value of the IRD on the Form 706 and the estate tax attributable to it. Executors of taxable estates should provide that schedule to beneficiaries who receive IRD.
3. It is claimed as an itemized deduction. Under IRC 67(b)(7), it is not a miscellaneous itemized deduction, so it remains deductible even while miscellaneous itemized deductions are suspended.

This deduction is regularly missed. When an IRA beneficiary of a taxable estate takes distributions for years without claiming it, that is real money left with the IRS.

A simple illustration

A hypothetical shows how the deduction is spread. Suppose a $1,000,000 traditional IRA was included in a taxable estate, and the estate tax attributable to the net IRD was $400,000. The beneficiary who eventually withdraws the full $1,000,000 would deduct the full $400,000 over time. A beneficiary who withdraws $100,000 this year deducts a proportionate $40,000 this year. The deduction follows the income as it is received, which is why the beneficiary needs the executor's computation from the start.

Do not accidentally accelerate it

IRC 691(a)(2) has a trap. If the estate or a beneficiary transfers the right to receive IRD to someone else, the fair market value of the right can be taxed immediately to the transferor. Selling an installment note, for example, accelerates the remaining gain.

The statute carves out transfers to a person entitled to the IRD by reason of the decedent's death or by bequest, devise or inheritance. So distributing an IRD item to the beneficiary named in the will generally does not trigger acceleration. Selling it to a third party or using it to satisfy a pecuniary bequest may. Executors should talk through any disposition of an IRD asset before doing it.

Charitable planning

Because IRD carries income tax and a charity does not pay income tax, IRD assets are often the most efficient assets to leave to charity. A charity named as IRA beneficiary receives the full value. A child named as IRA beneficiary receives the value minus income tax. That decision is usually made during life, but executors should know the logic when they see it in an estate plan.

When the IRS gets involved

IRD problems tend to show up as automated notices a year or two later. The IRS sees a 1099 or W-2 that does not match a return, assumes the income was omitted, and proposes tax. Many of these resolve with a clear explanation showing who reported the income and where.

The ones that do not resolve easily usually involve an estate that never filed a Form 1041, an IRD item reported on the wrong return, or a beneficiary who did not realize an inheritance was taxable. Pull the transcripts early to see what has been reported, and to whom.

The same deduction applies when the estate itself collects IRD. If the estate receives the income and reports it on its Form 1041, the estate claims the 691(c) deduction for the estate tax attributable to that income, rather than the beneficiaries.

If you inherited an IRD asset and the IRS says you owe tax on it, call (813) 229-7100. Let's talk.