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How to minimize taxes if you inherit
income in respect of the decedent
By Cora M. Barnhart •
Bankrate.com
June 1, 2000 -- You can't take it with you.
And after you're gone, taxes may prevent your heirs from taking
it with them, too.
A little-known tax hits people who inherit certain
types of money that the Internal Revenue Service calls income in
respect of the decedent (IRD).
IRD is gross income that a person would
have received if that person hadn't died. Examples include savings
bond income, Individual Retirement Account payouts and unpaid sales
commissions.
IRD
distributions are different
Unlike most distributions from a person's estate, which are
received tax-free unless they exceed certain limits, someone receiving
IRD must pay regular income tax on the distribution. Extra taxes
are imposed on the beneficiary if IRD isn't properly reported in
the decedent's final income tax return.
In some particularly unfortunate cases, the
income receives an additional wallop by a generation-skipping transfer
tax -- an additional, flat 55-percent tax imposed on gifts or bequests
to grandchildren that exceed $1 million.
Last week's tax tip explained how the IRS imposes
income and estate taxes on IRD.
This week's tax tip helps survivors left behind
who could be zapped by this little-known tax.
So, your great-Aunt Wilma passes on and names
you as a major beneficiary in her will. You work through your grief
and start figuring out what to do with her final bequest to you.
Your excitement regarding your new income subsides, though, as you
watch your newfound wealth dwindle in the face of income, estate,
and generation-skipping taxes.
There is one small glimmer of light for IRD
recipients.
Itemizing their federal income tax returns entitles
them to receive a deduction for the federal estate tax paid on that
income. Unlike other deductions, this one isn't subject to the 2
percent floor on miscellaneous itemized deductions.
Wages
and bonds
Beneficiaries tend to find themselves struggling with two types
of IRD in particular, wages and savings bonds.
In the case of wages, IRD will be any wages
or other employee compensation earned by the decedent but unpaid
at the time of death. IRD isn't subject to federal income tax withholding.
However, they may be subject to Social Security and Medicare taxes.
These additional taxes are due if the IRD is paid during the calendar
year of death. Wages paid as IRD after the year of death generally
are not subject to withholding for any federal taxes.
In the case of IRD on series EE or series I
U.S. Saving Bonds, the potential for overpaying taxes is even greater.
Check to see if the decedent reported the interest each year. Why?
The only interest the beneficiary is supposed to report on his return
is the interest earned after the date of death.
Overlooking this point can result in a much
higher tax bill for the beneficiary. Any increase in value of these
bonds, including any interest earned, in the year of death up to
the date of death is supposed to be reported on the decedent's final
return. Interest payments for previous years have already been taxed.
This isn't a trivial deduction to work through.
Don't hesitate to seek professional help. Consult Publication
559 for information about figuring the amount of this deduction.
For more on handling the tax returns of decedents,
see Chapter
4 of the IRS' Publication
17, "Your Federal Income Tax."
-- Posted June 1, 2000
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