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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Common Wealth Transfer Mistakes

A legacy plan is a vital part of the financial planning process, ensuring the assets you have spent your entire life accumulating will transfer to the people and organizations you want, and that family members are prepared to inherit and execute your wishes.  However, four common errors can derail this wealth transfer, and send individuals, families, and their legacies, off track.  Kiplinger’s recent article entitled “4 Reasons Families Fail When Transferring Wealth” explains further.

Failure to create a plan. It’s hard for people to think about their own death and the process can be intimidating. This can make us delay our estate planning. If you don’t have the appropriate estate plan in place, your goals and wishes won’t be carried out. So, it is important to have a legacy plan in place to ensure proper wealth transfer. A legacy plan can evolve over time, but a plan should be grounded in what your or your family envisions today, but with the flexibility to be amended for changes in the future.  See this article for an idea of how wealth transfer works in an estate plan and how to get the process started.  https://www.galliganmanning.com/how-to-begin-the-estate-planning-process/

Poor communication and a lack of trust. Failing to communicate a plan early can create issues between generations, especially if it is different than adult children might expect or incorporates other people and organizations that come as a surprise to heirs. Bring adult children into the conversation to establish the communication early on. You can focus on the overall, high-level strategy. This includes reviewing timing, familial values and planning objectives. Open communication can mitigate negative feelings, such as distrust or confusion among family members, and make for a more successful transfer.

Poor preparation. The ability to get individual family members on board with defined roles can be difficult, but it can alleviate a lot of potential headaches and obstacles in the future.  This is critical for wealth transfer in roles such as executors, trustees and agents.

Overlooked essentials. Consider hiring a team of specialists, such as a financial adviser, tax professional and estate planning attorney, who can work in together to ensure the plan will meet its intended objectives and complete a wealth transfer in accordance with your wishes.

Whether creating a legacy plan today, or as part of the millions of households in the Great Wealth Transfer that will establish plans soon if they haven’t already, preparation and flexibility are essential elements to wealth transfer success.

Create a legacy plan that is right for you, have open communication with your family and review philosophies and values to make certain that everyone’s on the same page. As a result, your loved ones will have the ability to understand, respect and meaningfully execute the legacy plan’s objectives.

Reference: Kiplinger (Aug. 29, 2021) “4 Reasons Families Fail When Transferring Wealth”

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What Happens to Your Will if You Get Divorced?

It is especially important to review your estate plan in a divorce situation.
It is especially important to review your estate plan in a divorce situation.

Every time you experience a life changing event, including divorce, it’s time to revisit your Will to make sure there are no unpleasant surprises for you or your family. As reported in the article “Rewriting Your Will After Divorce” from Investopedia, failing to review your current estate plan when contemplating a divorce can lead to results that you never intended.

Texas Law Can Save You

Luckily, in Texas we have several laws that cover you if you forget or don’t get around to writing your ex spouse out of your Will. Texas law presumes that after a divorce you do not want a former spouse to be a beneficiary under your Will or to act as your executor or agent under a power of attorney to make financial or medical decisions for you.

In fact, if you do want your former spouse to be your executor or agent, you need to reappoint them in new estate planning documents you execute after the divorce.

One thing to remember is that if your ex is a parent of your children, you will not be able to eliminate him or her as a guardian of your children if something happens to you while they are minors. The only way the other parent will not be allowed to be guardian of his or her child is if the parent is found unsuitable.

But you should still execute a new designation of guardian for your minor children in case your ex who is the parent is deceased or is found to be unsuitable to be guardian.

So, Where’s the Problem?

What if you pass away before the divorce is final? The law only applies to a divorced spouse, not if you are only separated or waiting for the divorce to be final. That’s why it’s a good idea to change your estate planning documents when you’re contemplating a divorce.

Issues With Some Retirement Plans

Also, Texas law cannot override a very harsh US Supreme Court case holding that state law does not apply to employer related retirement plans, such as 401(k)’s and 403(b)’s. These kinds of retirement benefits are subject to federal law which supersedes state law.

This US Supreme Court case, Egelhoff v Egelhoff, was decided in 2001. Mr. Egelhoff, an employee of Boeing Company, had a pension and life insurance policy that was provided by his employer.

Mr. Egelhoff, died in a car accident two months after his divorce, but before he changed the beneficiaries on his retirement and company life insurance.  Though the company still listed Mr. Egelhoff’s ex-wife as beneficiary, Mr. Egelhoff’s children by a previous marriage claimed that he had every intention of removing their stepmother as beneficiary and naming them, his children, as beneficiaries. That would seem to make sense given the circumstances.

Mr. Egelhoff’s children sued their father’s ex-wife for the retirement benefits and the life insurance, claiming that there was no way their father wanted his ex-wife to have the benefits to the detriment of his children.

The Court said that, under federal law, the company’s plan documents control who the beneficiary is and that the benefits would be distributed to the person who was listed with the company as beneficiary at the time of death, even if the beneficiary had been recently divorced from the employee.

The moral of the story is to make sure that beneficiaries on company related benefits are changed immediately after divorce to avoid the unfair result that happened to the Egelhoff children. State law cannot save you in that situation.

What’s Our Takeaway from This?

Every time there is a major life event (divorce, death of a family member, marriage, increase or decrease in wealth, illness, etc.) it is time to review your estate plan to make sure that it reflects what you want and need now. If you wait too long, things may not work out the way you want them to for your family and yourself.

Reference: Investopedia (September 14, 2021) “Rewriting Your Will After Divorce”

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