Minimizing The Tax Effects Of IRD

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Reprinted From:The News Journal
Written By: Nancy F. Blumberg, CPA-PFS, CFP
If you've planned for the transfer of your property at your death, you're probably aware that assets included in your estate get a step-up basis for income tax purposes. Therefore, the sale of that property will not result in a taxable gain to the heirs to the extent of the property's appreciation prior to death.

Although it can be beneficial for highly appreciated property to be included in a decedent's estate, you need to be aware that items considered income in respect of a decedent, or IRD, do not get this treatment.

Although IRD is fully incapable in the gross estate, the normal opportunity to avoid all income tax on appreciation existing at death is not available.

IRD includes income the decedent was entitled to receive at death but was never included as taxable income under the method of accounting for tax purposes. Uncollected salary and interest income of a cash- basis taxpayer, as well as vested pension benefits under a qualified plan are common examples of IRD. Installment sale obligations also can result in IRD.

Although these items are fully includable in the decedent's estate, they receive no basis step-up. Instead, basis carries over and the ultimate recipient of the IRD pays an income on all appreciation existing at death.

Some relief from this double tax situation is provided by allowing the recipient to deduct the incremental estate tax paid, if any, that is attributable to the inclusion of the IRD in the decedent's estate.

Although you should plan to minimize IRD, in many cases it is unavoidable (pension benefits). You can, however, plan to minimize the negative income tax effects.

The decedent or the executor can allocate IRD income to the estate beneficiary with the lowest marginal tax bracket or choose a charitable beneficiary for IRD property. By leaving IRD property to a charitable organization, you will avoid estate tax on the property by making use of the unlimited estate tax charitable deduction.

Because the charity is tax- exempt, the property also will escape income taxes when it receives IRD. Therefore, giving IRD property to charity will maximize the after-tax value of the assets available to your beneficiaries, charitable organization and family.