Income in Respect of Decedent for Trusts and Estates

One of the least understood income tax/estate planning problems concerns a critical issue involving IRA and pension plan account balances. The issue revolves around the topic of Income in Respect of Decedent (IRD).

IRD includes any income an individual is entitled to but does not receive over his or her lifetime. The best examples of IRD income are qualified plans, such as a profit-sharing or pension plan, 401k plan, rollover IRA and other such plans, annuities, accounts receivable and installment loans.

Here is the First Problem

Say your total estate is estimated at $2 million, you have $1 million in a qualified plan and you are subject to the maximum income tax and estate tax rates. Every dollar you take out is subject to income tax. Unless you spend it, the balance (after income tax) is subject to estate tax. In the highest 2010 brackets (35 percent income tax and 0 percent estate tax), your family gets only 67.9 percent – $679,692 – out of that $1 million.

As you may know, the highest tax brackets are scheduled to be 39.6 percent (income tax) and 55 percent (estate tax) in the year 2011. At that time, the amount your family will receive is significantly reduced to only $244,692.

Now, Here is the Second Problem

Your heirs will, in effect, pay the same amount that you would have paid had you withdrawn the funds during your life. In other words, IRD property will not pass to your heirs without someone paying taxes on the income. This double tax at death is called Income in Respect of Decedent (IRD).

If you haven’t done so already, it’s a good idea to consider the impact this could have on your family members and on your finances.