When a loved one dies, it can be an emotional experience. Unfortunately, handling the deceased’s finances can add to this stress. While most people know that you must file a final tax return for the deceased, most people do not know how to handle the income received after the person’s death. This income is known as ‘income in respect of deceased’ (IRD) and has its own special rules. Consider working with a financial advisor as you prepare an estate plan or implement a loved one’s estate plan.
What is income in relation to a deceased person?
Income in respect of deceased (IRD) is income received after someone dies but is not included in the person’s final tax return. When beneficiaries take over a deceased person’s finances, the situation can be complicated. This is especially true if they owned a business, had many types of bank and investment accounts, or were disorganized.
Examples of IRDs include:
Uncollected wages, salaries, allowances, commissions and holiday or sick pay
Distributions from deferred compensation
Exercise of stock options
Taxable distribution from retirement accounts
Interest on bank accounts
Dividends and capital gains from investments
Accounts receivable paid to a small business owned by the deceased (cash only)
This is a good reminder that people should have a detailed list of financial accounts and investments that beneficiaries can refer to. This will give them a to-do list to notify them of your death and avoid any lost bills in the shuffle.
How is IRD taxed?
IRD is income that would have been included in the deceased’s tax returns had they not died. If this income was not included in the final tax return, then it is considered IRD. Where the IRD is reported depends on who received the income. If paid into the estate, it should be included in the trust declaration. Where IRD is paid directly to a beneficiary then the beneficiary will need to include it in their tax return.
If property taxes are paid to the IRD received, the tax laws allow an income tax credit for property taxes paid on that income. For beneficiaries who lost the IRD estate tax credit, you may be able to amend your tax returns to claim it.
Impact of IRD on superannuation accounts
Retirement accounts can also be affected by the IRD. As investors get older, they must begin taking required minimum distributions (RMDs) from traditional IRAs, 401(k)s, and other taxable retirement accounts. Beneficiaries of these accounts must follow the distribution rules and make mandatory distributions as well.
RMDs for the year the decedent died are considered part of their estate. When the value of a decedent’s estate exceeds $11.7 million (2021 limits), the potential estate taxes can be significant.
The combination of estate taxes and income taxes on taxable retirement accounts can significantly reduce the value of an inheritance. The tax legislation allows for the deduction of estate taxes relating to amounts referred to as IRD to reduce the impact of this double taxation.
The bottom line
The IRD can quickly complicate finances for the deceased’s estate and beneficiaries. There are potential opportunities for tax savings, but the rules can be difficult to understand even for the most financially savvy individuals. For this reason, it helps to get a financial advisor and tax professional involved to make sure you’re not missing out on any income or assets and that your tax bill isn’t higher than it should be.
Estate planning tips
Knowing how to apply IRD to a deceased’s estate can be a challenge. It’s hard to focus on unusual rules and situations when you’re already distracted by the emotional impact of losing a loved one. Having a trusted financial advisor guide you through this difficult time can help you identify accounts and avoid missed opportunities for tax savings. Finding a financial advisor doesn’t have to be difficult. The SmartAsset Financial Advisor Matching Tool can quickly match you with multiple advisors in your area. If you are ready, start now.
Our tax return calculation takes into account your location, marital status, income and dependents. It allows you to estimate the effect on your taxes due based on changes in your income, dependents and federal withholding.
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