What Is “Income in Respect of Decedent?”

Estate administrators file a decedent’s taxes, and often that means income in respect of a decedent, which is post-death income.

While in a consultation recently, an executor brought up a discussion with a prior attorney.  The executor was told that the estate was “too small” to worry about taxes.  Although that was true for one tax, i.e. the Federal estate tax, there are actually multiple death taxes for executors to consider in an estate administration, most of which apply in more cases than the estate tax and are often overlooked by executors.

For example, every executor, trustee or administrator should consider “income in respect of a decedent” or “IRD”.  This kind of income has its own tax rules and they may be complex, says Yahoo! Finance in a recent article simply titled “Income in Respect of a Decedent (IRD).”

Incidentally, if you were looking for information on the estate tax, here are the basics.  https://www.galliganmanning.com/what-exactly-is-the-estate-tax/

Income in respect of a decedent is any income received after a person has died, but not included in their final tax return. When the executor begins working on a decedent’s personal finances, things could become challenging, especially if the person owned a business, had many bank and investment accounts, or if they were unorganized.

What kinds of funds are considered IRDs?

  • Uncollected salary, wages, bonuses, commissions and vacation or sick pay.
  • Stock options exercised
  • Taxable distributions from retirement accounts
  • Distributions from deferred compensation
  • Bank account interest (very common one)
  • Dividends and capital gains from investments
  • Accounts receivable paid to a small business owned by the decedent (cash basis only)

As a side note, this should serve as a reminder of how important it is to create and update a detailed list of financial accounts, investments and income streams for executors to review in order to prevent possible losses and to correctly identify sources of income.

How is IRD taxed? IRD is income that would have been included in the decedent’s tax returns, if they were still living but wasn’t included in the final tax return. Where the IRD is reported depends upon who receives the income. If it is paid to the estate, it needs to be included on the fiduciary return. However, if IRD is paid directly to a beneficiary, then the beneficiary needs to include it in their own tax return.

If estate taxes are paid on the IRD, tax law does allow for an income tax deduction for estate taxes paid on the income. If the executor or beneficiaries missed the IRD, an estate planning attorney will be able to help amend tax returns to claim it.

Retirement accounts are also impacted by IRD. Required Minimum Distributions (RMDs) must be taken from IRA, 401(k) and similar accounts as owners age. The RMDs for the year a person passes are also included in their estate. The combination of estate taxes and income taxes on taxable retirement accounts can reduce the size of the estate, and therefore, inheritances. Tax law allows for the deduction of estate taxes related to amounts reported as IRD to reduce the impact of this “double taxation.”

The key here is to work diligently with your tax preparer in an estate or trust administration to identify, report and pay for IRD.  Happily, estates have several costs which might be deductible to the IRD paid by the estate, such as funeral or administrative costs, meaning it is very possible no tax will be due even where there is substantial IRD.

In all events, if you are administering an estate you want to ensure IRD is addressed, and paid for if necessary.  One of the most important aspects of estate administration is providing a sense of finality, knowing that the legal and financial steps are finished so you can focus on your family in a difficult time.  Addressing the IRD ensures you don’t receive a letter from the IRS years later about unreported income.

Reference: Yahoo! Finance (Oct. 6, 2021) “Income in Respect of a Decedent (IRD)”

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Revocable vs. Irrevocable Trust – What’s the Difference?

Sometimes you need to look past the trust's name to see if it is truly revocable or irrevocable.
Sometimes you need to look past a trust’s name to see if it is truly revocable or irrevocable.

At first, the difference between a revocable trust and an irrevocable trust may appear very simple. One would think that, as the names imply, a revocable trust is one that can be terminated or amended, while an irrevocable trust is one that cannot be changed.  However, as often happens with the law, things aren’t always what they seem as reported in the article “What’s the difference between a revocable and irrevocable trust” from Market Watch. 

Sometimes you have to look beyond the name of the trust to determine if it is truly revocable or irrevocable.

A revocable trust, often referred to as a revocable living trust, is one that can be changed or terminated by the person who created the trust, whom we shall refer to as a trust maker. A revocable living trust is often used as a substitute for a Will because, like a Will, it can be amended by the trust maker depending on the circumstances, and it can help avoid probate if the trust maker’s property is titled in the name of the trust (or the trust is named as a beneficiary on the trust maker’s accounts and other assets).

But, a revocable trust becomes an irrevocable trust on the trust maker’s death. Also, the trust maker’s incapacity during life may result in a revocable trust becoming irrevocable. This can be confusing because the trust may keep the same name (for example, the John Doe Revocable Living Trust), but, if John Doe is deceased, the revocable living trust is really an irrevocable trust.

A revocable trust is considered almost an alter ego of the trust maker. As a result, a revocable trust does not provide creditor protection. From a tax standpoint, a revocable trust belongs to the trust maker and is included in the trust maker’s estate when calculating the estate tax.

As for an irrevocable trust, one would generally think that it is a trust that cannot be changed. But this impression, too, may be deceptive. A trust maker, beneficiary, or an independent person may be given powers to make certain changes to an irrevocable trust. Those changes may include the removal and replacement of a trustee and the ability to change or add beneficiaries.

An irrevocable trust is considered to be totally separate from the trust maker. It is usually constructed to avoid having the assets of the trust included the trust maker’s estate for estate tax purposes. An irrevocable trust can offer the beneficiary creditor and divorce protection, as well as prudent management of trust assets if the beneficiary is not good with financial matters. That’s why many parents create irrevocable trusts for their children when making gifts instead of making gifts to their children directly.

In addition to the trust maker giving the power in limited circumstances to change certain provisions of an irrevocable trust, an irrevocable trust may be “reformed” by a court, if it can be shown that the trust’s purposes can no longer be carried out.

And many states have passed laws allowing an irrevocable trust to be “decanted” – meaning that the assets of the original trust may be poured like wine into a new trust that includes provisions that are better suited to the current situation. These laws for the most part include safeguards to make sure that this is not a unilateral decision on the part of the trustee or the trust maker and the decanting is permitted only if it is in the best interests of the beneficiaries.

Of course, a trust maker may always prohibit reformation or decanting when creating an irrevocable trust, but, if the trust is to last for generations, it may make sense to allow limited ways for the irrevocable trust to adapt to changing circumstances.

So the next time you come across a reference to a revocable or irrevocable trust, look beyond the name to determine whether the trust is really revocable or irrevocable.

Reference: Market Watch (Oct. 8, 2021) “What’s the difference between a revocable and irrevocable trust”

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