The problem of the disappearing income: Income in Respect to a Decedent

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Professor McCouch describes a tax collector’s nightmare and whimsically calls it “the problem of disappearing income”. The scenario is as follows: The decedent, who uses cash based accounting has accrued income but dies before she receives the cash. In consequence, this income does not properly go on her tax return. The estate collects it and distributes it to the beneficiaries and these would take it with a new basis (stepped up), and thus, neither pay ordinary income taxes nor capital gains IRC section 1014(a). This income is called Income in Respect to a Decedent (IRD). To avoid loss of tax revenue under theses circumstances, Congress has enacted two provisions IRC section 1014(c) which specifically denies the beneficiary the fresh start basis that applies to other property acquired from a decedent, and IRC section 691(a) which provides that IRD must be included in gross income by the deceased taxpayer’s estate.

In consequence of above, items of IRD may be subject to income tax paid by the beneficiaries and, additionally, be taxed to the estate. This potentially could create double taxation. IRC section 691(c) therefore allows a successor who reports an item of IRD to claim an income tax deduction for a pro rata portion of the estate tax, if any, that was imposed on the decedent’s death.

To recap, when an estate or other successor receives a right to income that is classified as IRD, the item is included in the recipient’s gross income (without a fresh-start basis) and the recipient may have an income tax deduction for any estate tax attributable to this item.

MCCOUCH, G. M. P. (2020). Federal income taxation of estates, trusts, and beneficiaries in a nutshell.

Related: What are Income in Respect of a Decedent (IRD) and the IRD deduction?

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