Michael Kitces writes about mitigating the combined income and estate taxation of pre tax assets, such as IRAs, by using the IRD deduction under Code Sec. 691(c). Michael’s article begins as follows:
Pre-tax assets like IRAs can face a significant income tax burden as their value grows, a challenge that is only made worse for those who are subject to estate taxes on those assets as well. In the extreme, the combination of the two can consume the majority of the value of an inherited IRA bequeathed to a beneficiary.
To help mitigate the combined income-and-estate-tax effect, the Internal Revenue Code allows for an “Income in Respect of a Decedent” (IRD) deduction under Section 691(c). Claimed by the beneficiary of an inherited IRA to the extent of any estate taxes that were caused by the account, the deduction can be material – as much as 40% of the value of the account!
Yet despite its size, beneficiaries in practice often “miss” the IRD deduction, not realizing it was there to claim, or perhaps “losing track” of it when changing accountants or tax preparation software. Fortunately, an amended tax return can be filed to claim a missed IRD deduction from recent years – but only the past 3 years. Which means going forward, anytime an inherited IRA appears with a new client, a good best practice for all advisors is to ask: “did the decedent who left you this account pay any estate taxes?” and if so, be certain the IRD deduction is claimed properly!
And notably, in the end the IRD deduction applies not only to inherited IRA accounts, but also other employer retirement plans, inherited non-qualified annuities, employer non-qualified stock options, deferred compensation, employer NUA stock, and more!
Posted by Lewis J. Saret, Co-General Editor, Wealth Strategies Journal.