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Income in Respect of a Decedent

I began writing a post regarding strategies for those who might die with more than the $2M current estate exemption, and saw a question come up on the misc.taxes.moderated newsgroup (huh? well, before the web, there was still an internet, text based, and newsgroups were a big thing).
Here’s the full question:

Let’s say that one’s estate consists entirely of a tax-deferred account (IRA or 401k) containing $2.5 million. That exceeds the current $2 million estate tax credit, so is $500K subject to estate tax? Or, because there is a deferred tax liability on the $2.5 million, does the law allow adjustment of the account value to recognize that income tax liability before determining the size of the estate? Could an heir withdraw the full account value, pay income tax on the withdrawl, and then determine the estate value, or is the estate tax due on the full amount of the account pre-tax, in addition to the deferred income tax?

Now, I realize this is not a question at the top of everyone’s mind, but it can have quite an impact on the children of someone passing whose money is in tax-deffered accounts. As I posted on the newsgroup, the issue is addressed by the “income in respect of a decedent” (IRD) rules as described in great details at The CPA Journal in an article that explains that the estate tax paid is available as a credit when the IRA withdrawals commence. If this were not the case, an IRA or 401(k) could be subject to both estate and income tax as high as 80% combined. I’ve found that the IRD rules are not well known, but perhaps they should be. For further reading see Ed Slott’s ‘Parlay Your IRA into a Family Fortune‘.

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