Income in Respect
of a Decedent

What qualifies as IRD

Under Section 691(a), income in respect of a decedent is income to which the decedent had a right at the time of death but that was not properly includable on the final income tax return under the decedent’s method of accounting. For a cash-basis taxpayer (the vast majority of individuals), this means income that was earned or accrued but not yet received before death.

Common IRD items include:

• IRA and qualified retirement plan distributions (the single largest source of IRD in most estates)
• Accrued salary, wages, bonuses, and commissions
• Accrued interest and dividends declared before death but paid after
• Accounts receivable for cash-basis sole proprietors and professionals
• Installment sale payments (the gain element of remaining installments under Section 691(a)(4))
• Renewal commissions and residual payments
• Deferred compensation payments
• Savings bond interest not previously reported
• Distributive share of partnership or S corporation income through date of death

The critical characteristic is that the decedent had an enforceable right to the income before death, even if receipt was contingent on future events. If the right existed at death, the income is IRD regardless of when payment actually occurs.

Where IRD is reported

IRD is not reported on the decedent’s final Form 1040. The final return includes only income received (or constructively received) through the date of death.

IRD is reported by whoever ultimately receives it:

• If the estate collects the income (e.g., a final paycheck paid to the estate), it is reported on the estate’s Form 1041
• If a beneficiary receives the income directly by operation of law or beneficiary designation (e.g., an inherited IRA), it is reported on the beneficiary’s Form 1040
• If the estate distributes the right to receive the income to a beneficiary (e.g., assigning accounts receivable), the beneficiary reports it when received

The distinction between the final 1040 and the first 1041 is one of the most common errors in estate administration. Accrued interest, final dividends, and partial-month pension payments are frequently placed on the wrong return. The date of death is the dividing line, and the decedent’s method of accounting determines which side each item falls on.

No step-up in basis

Section 1014(c) explicitly provides that the stepped-up basis at death does not apply to items constituting income in respect of a decedent under Section 691. This is the single most important characteristic of IRD and the one that creates the most tax exposure.

Every other asset in the estate receives a basis equal to its fair market value at date of death (or alternate valuation date). IRD items do not. An inherited IRA worth $500,000 has a basis of zero. When the beneficiary takes distributions, every dollar is ordinary income, exactly as it would have been to the decedent.

This is also why IRD creates the potential for double taxation: the IRD is included in the gross estate for estate tax purposes under Section 2031, and it is also subject to income tax when received. The Section 691(c) deduction exists specifically to mitigate this overlap.

Character preservation

IRD retains the same character it would have had if received by the decedent. Ordinary income stays ordinary income. Long-term capital gain stays long-term capital gain. Tax-exempt income stays tax-exempt. This character flows through to whoever reports the income, whether the estate or a beneficiary.

For installment obligations, the gain element of each payment retains its character (capital gain or ordinary, depending on the underlying transaction). The interest element is ordinary income but is not IRD; it accrues after death and belongs to whoever holds the note.

The Section 691(c) deduction

When IRD is included in the decedent’s gross estate and federal estate tax is paid on it, Section 691(c) allows the person who includes the IRD in income to deduct the federal estate tax attributable to that IRD. This is an above-the-line deduction for estates and trusts (deducted on Form 1041) and an itemized deduction for individuals that is not a miscellaneous itemized deduction (IRC 67(b)(7)), so it is not affected by the permanent disallowance of miscellaneous itemized deductions under IRC 67(h).

The computation requires two estate tax calculations:

1. The actual federal estate tax liability (as reported on Form 706)
2. A hypothetical estate tax liability computed by subtracting all net IRD items from the gross estate

The difference between these two numbers is the total Section 691(c) deduction available. It is allocated among all IRD items proportionally. If the estate collects some IRD and beneficiaries collect the rest, each party takes the portion of the deduction that corresponds to the IRD they reported.

This deduction is frequently missed, especially on beneficiary returns. When a beneficiary inherits a large IRA from an estate that paid federal estate tax, the 691(c) deduction can offset a substantial portion of the income tax on IRA distributions. We compute it on every engagement where it applies and push the calculation to the beneficiary’s preparer when we do not handle their return.

Installment obligations

Under Section 691(a)(4), if the decedent held an installment obligation at death, the remaining payments are treated as IRD. The unreported gain in each payment is IRD; the basis recovery portion is not.

If the installment obligation is transferred by the estate or beneficiary (by sale, exchange, gift, cancellation, or satisfaction at other than face value), all remaining gain accelerates under Section 691(a)(5). This includes a deemed transfer if the obligation becomes unenforceable. The acceleration can create a significant tax liability in a single year.

The estate does not recognize gain merely by distributing the installment note to a beneficiary. The beneficiary steps into the decedent’s position and picks up the gain as payments are received.

Deductions in respect of a decedent

Section 691(b) provides the mirror image of IRD: deductions that the decedent was entitled to but that were not allowable on the final return. These include accrued business expenses, interest, taxes, and depletion. They are deductible by whoever would have been entitled to claim them, in the same manner and to the same extent as the decedent.

The interaction between deductions in respect of a decedent and the Section 642(g) election (choosing between the estate tax return and the income tax return for certain deductions) requires careful coordination to maximize the overall tax benefit.

What we handle

• Identifying all IRD items across the final 1040, Form 1041, and beneficiary returns
• Correctly allocating income between the final return and the estate’s first 1041
• Computing the Section 691(c) deduction and allocating it among the estate and beneficiaries
• Installment obligation reporting, including acceleration analysis for transfers and dispositions
• Coordinating IRD reporting with beneficiary K-1s and pushing the 691(c) calculation to beneficiary preparers
• Deductions in respect of a decedent under Section 691(b)
• Coordinating with Form 706 to ensure IRD items are properly valued in the gross estate

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