701

Income in Respect of a Decedent

All amounts of gross income that are not properly includible in the final return but that the decedent had a right to receive and could have received had he or she continued to live are treated as income in respect of the decedent.

701

IRD Reported When Received

These amounts must be included in gross income for the tax year when received by the estate or person receiving such amount by reason of inheritance or survivorship through the decedent, regardless of whether such recipient reports income on the cash or accrual method of accounting.

Sec. 691(a)(1); Reg. 1.691(a)-2701

If a sale has been completed and the estate receives the proceeds after death, the gain is income in respect of a decedent and is taxable to the estate.

If the executor of the estate completes a sale that the decedent had negotiated, gain on the sale is taxable to the estate although it is not income in respect of a decedent.

Reg. 1.691(1)-2(b), Example 5701

No IRD Under the Accrual Method

If a decedent on the accrual basis completes a sale before death and the proceeds are received after death by the estate, the gain will be included in the decedents final income tax return and the proceeds will not be income in respect of a decedent taxable to the estate.

701

In order for a sale to be considered income in respect of a decedent by a cash-basis taxpayer, the following conditions must be met before the taxpayers death with the payment following death:

1.The decedent entered into a legally significant contract.

2.The decedent performed the substantive preconditions to the sale.

3.No economically material contingencies existed a the time of the decedents death that might have disrupted the sale.

4.The decedent would have received the sale proceeds (actually or constructively) if he or she remained alive.701

A decedents income tax is taxed to the recipient retains the same character it would have had in the hands of the decedent if he or she had lived and received the income.

Thus, if the income would have been capital gain, exempt income, or dividend income to the decedent, it continues to be the same kind of income to the recipient.

Sec. 691(a)(3); Reg. 1.691(a)-3701

S Corporation Stock

Any person who acquires stock in an S corporation by reason of a bequest, devise, or inheritance from a decedent must treat as income in respect of a decedent the pro rata share of any item of income of the corporation that would have been income in respect of a decedent If the income had been acquired directly from the decedent.

Sec. 1367(b)(4)(A)701

Reduce S Corporation Stock Basis

The stepped-up basis of the stock acquired from a decedent is reduced to the extent that the stocks value is attributable to items consisting of income in respect of a decedent.Sec. 1367(b)(4)(B)

701

IRD Also Included in the Gross Estate

It should be noted that rights to income to be collected after death are usually part of the decedents estate subject to federal estate tax.

Because of the income-in-respect-of-a-decedent rules, such income is taxed to the recipient even though, for income tax purposes, it has a basis equal to the amount includible for estate tax purposes.702

Estate Tax Deductible on Income Tax Return

However, the law give partial relief from this duplication of taxes by allowing a deduction to the recipient of the income based on the increase in the estate tax attributable to the inclusion of the value of such income right in the estate.

702

Sam Wilson who kept his books on the cash basis, was entitled at the date of his death 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 installments to the residuary legatee of the estate.

Wilsons estate must include in its gross income the two installments received by it, and the legatee must include in his or her gross income each of the three installments received.702

A claim owned by Dan Jacobs, who reported his income on the cash basis, was in the process of litigation at the time of his death.

Before administration of Jacobs estate was complete, the claim was settled for $10,000.

The $10,000 is income in respect of a decedent and is required to be included in the income of the estate in the tax year in which received.702

Assume the same facts as the previous example, except that Dan Jacobs estate, which makes its returns on the cash basis and for a calendar-year period, received $6,000 on account of the claim on February 15, Year 1.

On March 20, Year 1, before it collects any more, the estate is wound up and the account receivable for the balance is distributed, together with other assets, to Harry Smith, Dan Jacobs sole heir. 702

Smith makes his returns on the accrual basis and for a calendar-year period. He collects the balance on February 4, Year 2.

The estate includes the $6,000 on its Year 1 return, and Smith includes the $4,000 on his Year 2 return.

Smith is not to accrue the $4,000 in Year 1, the year it was distributed, because it is taxable to him in the year he receives the money even though he is on the accrual basis.702

Francis Jackson, uses the cash method of accounting and sells his crop to a processor for $5,000, but did not receive payment before his death.

The processor pays the $5,000 to Jacksons estate.

The payment is taxable to the estate as income in respect of a decedent.

Had Jackson used the accrual method of accounting, however, the $5,000 payment would have been includible on his final return, and the estate would not realize income when it received the payment.702

Xavier Lucas, before this death, acquired 10,000 shares of the capital stock of the Y Corporation at a cost of $100 per share.

During his lifetime, Lucas had entered into a contract with Y Corporation or with other shareholders whereby Y Corporation or other shareholders agreed to purchase, and Lucas agreed that his executor would sell, the 10,000 shares of Y Corporation stock owned by Lucas at the book value of the stock at the date of his death.

Upon Lucas death, there is no income in respect of a decedent based on the appreciation in value of Lucas stock to the date of his death.702

Juan Hernandez has an employment contract under which he is to be employed for life at fixed annual salaries, and, after his death, payments are to be made to his widow.

The payments are to be based on Hernandezs salary.

Payments made under the contract to his widow are income in respect of a decedent.

A.V. Bernard, DC N.Y., 63-1 USTC 9340, 215 FSupp 256703

Zachary Banks, an inventor, sells the patent rights to one of his inventions.

Royalties accruing and paid after his death are income in respect of a decedent.

If, however, the transfer of the patent rights is a nonexclusive license (rather than a sale), only royalties accrued and due at Banks death are income in respect of a decedent. Royalties accruing after his death are ordinary income to the recipient.

Rev. Rul. 60-227, 1960-1 CB 262 clarifying and distinguishing Rev. Rul. 57-544, 1957-2 CB 361703

Mickey Taylor was entitled to two week of vacation at the time of his death, and his employer makes the vacation payments to Taylors estate.

Such payments are income in respect of a decedent.

703

If a right to receive income in respect of a decedent is transferred by the owner of the right (the estate, heir, or other beneficiary) to another person, the fair market value of the right at the date of the transfer is to be included in the income of the transferor, plus the amount by which any consideration received for the transfer exceeds the fair market value of the right.

Sec. 591(a)(2)703

Thus, if the right to receive the income is disposed of by sale, the fair market value of the right or the consideration received, whichever is higher, is includible in the sellers gross income.

If the right is disposed by gift, the fair market value of the right will be includible in the donors gross income.

Reg. 1.691(a)-4(a)703

Joe West bequests to his son, Danny, the right to receive rental payments from certain real estate.

To obtain immediate cash, Danny sells the right to receive the rental payments to John Farley.

The fair market value of the right at the date of transfer is $10,000.

The sales price is $8,000.

Danny will have to include $10,000, the fair market value of the right, in his gross income in the year of transfer.

If Danny had made a gift, the fair market value of the right at the time of the gift, here $10,000, would have been includible in his gross income.

If he had done neither, the rental income would have been taxed to him as received703

A transfer of a right to receive income in respect of a decedent includes

(1) a sale, exchange, or other disposition;

(2) the satisfaction of installment obligations at other than face value; or

(3) the cancellation of an installment obligation.

It does not include a transfer at death to the estate of the decedent or a transfer to a person who would eventually be entitled to the income by reason of the death of the decedent by bequest, devise, or inheritance.703

Jamie Santos bequeaths his right to certain payments of income to a trust.

If the trust terminates and the right to the payments is transferred to the beneficiary, the trust does not have to include the fair market value of the right to receive the payments in its income, but the payments are includible in the income of the beneficiary.

703

Installment Obligations Acquired from Decedent

Installment obligations acquired from a decedent are to be treated as items of income in respect of a decedent.

Therefore, the estate, heir, or other person receiving the installment payments after the death of the decedent will use the same gross profit percentage that the decedent used to arrive at the portion of each collection that represents taxable income.`Sec. 691(a)(4)704

If the estate, heir, or other recipient sells or exchanges the installment obligation, the transferor (estate, heir, etc.) should include in its gross income the fair market value of the obligation at the time of the sale or exchange, or the consideration received for the transfer, whichever amount is greater, reduced by the basis of the obligation (i.e., the decedents basis, adjusted for all installment payments received before the disposition).

The basis of the obligation in the hands of the decedent is the excess of the face value over the amount of income that would be returnable had the obligation been satisfied in full.Sec. 453B(b)704

Ann Jessup, the heir of a decedent, is entitled to collect an installment obligation with a face value of $100, a fair market value of $80, and a basis in the hands of the decedent of $60.

If Jessup collects the obligation at face value, the excess of the amount collected over the basis is considered income in respect of a decedent and is includible in Jessups gross income.

704

In this case, the amount includible would be $40.

If Jessup collects the obligation at $90, an amount other than face value, the entire obligation is considered a right to receive income in respect of a decedent.

The amount required to be included in Jessups gross income is the consideration received in satisfaction of the installment obligation (because it is greater than market value) less the amount of the basis of the obligation in the decedents hands.

In this case, the amount includible would be $30.704

Bonuses

With respect to bonuses, several courts have taken the liberal position that bonuses may be taxed as income in respect of a decedent even when no right to the bonus existed at the time of death and the amount of the bonus was not determined until after death.

E. ODoaniel Est., CA-2 49-1 USTC 9235, 173 F2d 966; E. Bausch Est., CA-2, 51-1 USTC 9146, 186 F2d 313704

Other types of compensation that are considered income in respect of a decedent are accrued vacation allowances, [Rev. Rul. 59-64, 1951-1 CB 31; Rev. Rul. 86-109, 1986-2 CB 196]

Lump-sum payments of accrued annual leave, [Rev. Rul. 55-229, 1955-1 CB 75] and

A decedents interest in fees and commissions. [J.M. Enright, SCt. 41-1 USTC 9356, 312 US 636]704

Also, transactions that arise after the decedents death may receive IRD treatment.

For instance, the right to received renewal commissions is an example of compensation that may be characterized as income in respect of a decedent.

Reg. 1.691(a)-2(b)(2)

704

Crystal Christenson 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.

Christenson died before she received all of the commissions, and her son inherited the right to receive the remainder.

The commissions received by Christenson were includible in her gross income. 705

The commissions received by her son were not includible in Christensons gross income but must be included in the sons gross income.

The commissions in the sons hands represent a decedents income.

Christenson being the decedent for this purpose.

705

Deduction for IRD Included in Gross Estate

An estate or other person taxed on income in respect of a decedent is entitled to a deduction for any federal estate tax (and any generation-skipping transfer tax) imposed on the decedents estate that is attributable to such income.

Sec. 691(c)(1)

705

The deduction must be itemized [Rev. Rul. 78-203, 1978-1 CB 199] and, therefore, does not reduce a recipients adjusted gross income.

The deduction for estate tax paid in the case of income in respect of a decedent is not included in the definition of the term miscellaneous itemized deduction and, therefore, is not subject to the two percent floor that is generally applicable to such deductions.705

Computing the deduction requires a determination of the amount by which net income in respect of a decedent exceeds the deductions from the gross estate for claims representing (1) the deductions and (2) the credit in respect of a decedent.

Sec. 691(c)(2); Reg. 1.691(c)-1(a)(1)

705

The excess is the net value of the relevant items of income in respect of a decedent.

The estate tax attributable to such net value is the actual estate tax (reduced by the credits against it) less an estate tax computed independently of such value.

This amount is apportioned among the various recipients of the income in respect of a decedent.

This deduction is available even though part of the income items may qualify for the marital deduction.705