Probably for the same reason
people tend to put off making their wills,
taxpayers often neglect to plan for the effects on
their heirs of income they were entitled to
receive but didn’t live long enough to see.
So-called “income in respect to a decedent”
(IRD) includes, for example, a final paycheck or
other income distributed after an employee’s
death. Failure to plan for this income can cost an
estate and its beneficiaries a lot of money.
Reduce IRD’s impact with these six tips:
Name the spouse as beneficiary of
retirement accounts. For married
taxpayers, perhaps the easiest way to delay the
bite of much of the IRD from IRAs and other
retirement accounts is through a spousal rollover.
This strategy generally postpones any estate tax
on the accounts and slows the imposition of income
taxes on the payouts. A surviving spouse receiving
an IRA rollover can generally delay required
minimum distributions from the IRA until he or she
reaches the age of 70½, and then payments can be
stretched out over his or her remaining lifetime.
In addition, under the Pension Protection Act of
2006, a decedent’s IRA may be rolled over into one
established for the benefit of a non-spouse
beneficiary, who is then subject only to minimum
distribution requirements of inherited IRAs.
Name a younger beneficiary to the
survivor’s IRA. Doing so may
further stretch out payments. If the survivor dies
before the required beginning date for taking
minimum distributions, the amount to be
distributed is determined by dividing the account
balance at the beginning of the year following the
death by the beneficiary’s remaining life
expectancy. If the survivor was already taking
minimum distributions when he or she died, then
the account balance is divided by the larger of
the owner’s or beneficiary’s remaining life
Funnel IRD assets into a credit shelter
trust. Where preserving assets
for children by fully using the estate tax
exemption for both spouses is paramount, a credit
shelter trust may be the right choice. When the
first spouse dies, an amount equal to his or her
exemption—currently $2 million—passes to a trust
from which the surviving spouse can benefit during
his or her lifetime but which will not be included
in his or her estate at death.
Donate IRD assets to charity.
Specific pre-residuary bequests
fulfilled with IRD assets will save the estate
taxes on the value of the IRD assets used [because
of the unlimited charitable deduction of IRC
section 642(c)], as well as the taxes that the
non-charitable residual beneficiaries would have
otherwise had to pay on the IRD asset as they
received the income.
Don’t overlook the IRD income tax
deduction. An amount equal to
the portion of estate tax attributable to net IRD
items after deductions the decedent would have
taken is treated as a miscellaneous itemized
deduction not subject to the 2% of adjusted gross
income floor or the alternative minimum tax.
However, because IRA payments typically are spread
out over a period, such as the taxpayer’s life
expectancy, the maximum deduction is also spread
out over that period. If the taxpayer doesn’t use
up the deduction before his or her death, it can
be carried over to his or her heirs. Doing so
requires careful recordkeeping.
Favor the Roth IRA. Since
Roth IRAs are not considered IRD assets and
qualified distributions from them are not subject
to income tax, your clients can consider making
contributions to a Roth versus a traditional IRA.
The trade-off is that they miss out on the
current-year tax deduction they would receive for
contributions to a traditional IRA. Clients who
have already set up a traditional IRA can consider
the tax implications of rolling it over into a
Roth IRA. A distribution to a beneficiary or to
the Roth IRA owner’s estate on or after the date
of death is a qualified distribution if it is made
after the five-taxable- year period beginning with
the first tax year in which a contribution was
made to any Roth IRA of the owner.
David Desmarais, CPA/ABV,
is a partner in the firm of
Charron & Rosen LLP, Boston.