Tax Information: What Is Irs Section 691?

Learn about income in respect of a decedent (IRD) and how the deduction allowed in IRS Section 691 can help preserve assets and save thousands.

Section 691 of the Internal Revenue Code deals with income in respect of a decedent (IRD). This occurs when income is accrued, but not yet distributed at the time of death of the decedent. Income in respect of a decedent assets can include, but are not limited to: deferred compensation, qualified retirement plans, accrued interest, stock dividends, contract receivables, and gains on installment sale contracts. There are three possible recipients of this income: the decedent's estate, a named beneficiary, or a beneficiary who receives the amount by bequest, devise, or inheritance after a distribution by the decedent's estate. The income is not reported on the decedent' s final tax return, but rather should be included in the gross income, for the taxable year when received, of the recipient of the income. It should however, be included in the decedent's gross estate for estate tax purposes (IRC Sec. 2033). In the case of a sale, if the IRD represents a gain (ordinary or capital), the recipient may utilize the decedent's basis to offset the gain. The basis does not step up to the fair market value at death, even though the IRD is included in the gross estate.

Subsection (c) allows for an often overlooked deduction that can help save thousands if used properly. Business expenses, interest, income production expenses, and taxes owed by the decedent, but not allowed on the final form 1040 can be deducted by the estate in the tax year paid. Likewise, if a beneficiary receives income from a decedent and is obligated to pay any of these expenses, they're deductible as well. The full amount of income is taken into gross income as received, but the recipient is allowed to deduct the federal estate tax paid that is attributable to the IRD. With proper planning, this valuable deduction can protect the recipient from the double taxation of the estate tax and income tax immediately upon the decedent's death. The income tax effect can be further reduced with certain assets such as IRA's if the individual beneficiaries are allowed to minimize withdrawals over their life expectancy. This allows more of the asset to continue to grow tax-deferred because there is a smaller amount being distributed each year.

Where beneficiaries can preserve the most out of the asset, however, is to successfully utilize the IRD income tax deduction. For example, assume you were to inherit a $1 million IRA from a parent who has a $2 million estate. The estate tax would be calculated with all the taxable assets, including IRD assets such as the IRA. Depending on certain factors, the estate tax would come out to about $900,000. You then calculate the estate tax excluding the $1 million IRA, which will come out to roughly $480,000. The $420,000 difference represents the maximum IRD income tax deduction that can be taken with regards to the IRA. Because IRA payments are spread out over time, the maximum deduction is also spread out over that same period. The deduction can also be carried over to an heir if not fully used in your lifetime.

Section 691 provides an extremely valuable deduction that can significantly preserve estate assets, but it is important to follow other key steps that are essential to maximizing the result. The correct beneficiary and minimum distribution designations must be made along with a minimum distribution plan. It is also very important to properly fund for the inevitable estate tax through life insurance and gifting.

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