Income Tax Issues Related to Decedents
The term income with respect to a decedent refers to those amounts to which a decedent was entitled but which were not properly includible in computing his/her taxable income for the taxable year ending with the date of his/her death or for a previous taxable year under the method of accounting employed by the decedent[i].
Thus, any income that a decedent is entitled to receive should be included in the estate’s gross income. In Halliday v. United States, 655 F.2d 68 (5th Cir. Ala. 1981), the court held that the Internal Revenue Code and concomitant regulations do not expressly require that the decedent have a legally enforceable right to the income.
The taxable income in respect of a decedent includes:
- the entire portion of a deceased partner’s distributive share of partnership income up to the date of his death[ii].
- payments made by a partnership in liquidation of the deceased partner’s interest which are considered to be a distributive share of partnership income or a guaranteed payment[iii].
- interest accruing on term savings certificates between the last interest payment date and the date of death[iv].
- compensation for personal services received after death, even if the deceased employee didn’t have a legally enforceable right to receive the compensation[v].
- bonus for the services of the decedent received after death[vi].
- deferred compensation, consisting of:
- compensation that had been payable to the decedent, but the receipt of which he elected to defer under his employer’s deferred compensation plan,
- shares of stock in the employer/corporation that had been payable to the decedent as a result of his exercise of compensatory stock options granted to him by the employer, the receipt of which the decedent elected to defer under the employer’s deferred stock option plan, and
- a death benefit which the decedent had negotiated with the employer for the employer to provide to the decedent’s estate or to designated beneficiaries upon the decedent’s death.
- medical insurance reimbursements received by an estate in a year later than the year in which the decedent deducted the medical expenses[vii].
- qualified employee plan distributions to a deceased employee’s estate or beneficiaries[viii].
- amount received in excess of the owner-annuitant’s investment in a contract by a deferred annuity contract’s beneficiary, where owner-annuitant died before the annuity starting date[ix].
Apart from the above mentioned income, if substantially non-vested property has been transferred in connection with the performance of services and the person who performed such services dies while the property is still substantially non-vested, any income realized on or after such death with respect to such property is income with respect to a decedent[x].
The income received after death should be attributable to activities and economic efforts of the decedent in his/her lifetime and these activities and efforts must give rise to a right to that income. The right is to be distinguished from the activity that creates the right. If there is no such a right, no matter how great the activities or efforts, there would be no taxable income[xi].
Income with respect to a decedent may also be referred to by such names as post-mortem, after-death, transmitted, posthumous, or subsequent income.
The amount of all items of gross income with respect to a decedent which are not included with respect to the taxable period in which falls the date of his/her death should be included in the gross income, for the taxable year when received, by[xii]:
- the estate of the decedent, if the right to receive the amount is acquired by the decedent’s estate from the decedent;
- the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent’s estate from the decedent; or
- the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent’s estate of such right.
The income of the decedent has the same character in the hands of the recipient as it had in the hands of the decedent[xiii]. The right to receive an amount of income with respect to a decedent is treated as in the hands of the estate or beneficiaries and is considered as having the same character it would have if the decedent had lived and received such an amount[xiv].
The shifting of taxability of income with respect to a decedent from the decedent to a recipient applies to successive transfers by death[xv]. For instance, a widow acquired, by bequest from her husband, the right to receive renewal commissions on life insurance sold by him in his lifetime, which commissions were payable over a period of years[xvi]. The widow died before having received all such commissions and her son inherited the right to receive the rest of the commissions. The commissions received by the widow were includible in her gross income. The commissions received by the son were not includible in the widow’s gross income but must be included in the gross income of the son.
When an individual dies, any income tax return which is due for the decedent’s final year must be filed by the estate representative, who must determine which items of income and deduction are to be reported on the return. This will depend principally on the method of accounting used by the decedent at the time of death.
A final tax return is filed for an individual in the year of his/her death[xvii]. A final return means the decedent’s federal individual income tax return for the year of death. A decedent’s final income tax return includes income and deductions through the date of death. The preparation of a decedent’s final federal income tax return is the responsibility of a personal representative.
Generally, expenses which a decedent paid before death should be deducted on the final return. Usually, a personal representative signs the return. When a joint return is filed, the surviving spouse also must sign the return.
A joint return may be filed for a decedent and his/her surviving spouse as long as the surviving spouse has not remarried at the end of the year of death and the personal representative and surviving spouse both agree to file a joint return.
Moreover, income received after death should be reported on the estate income tax return. The filing of a return and the payment of tax for a decedent may be made as though the decedent had lived to the end of his/her last tax year[xviii].
Deductions are allowed from gross income for a decedent’s expenses, interest, taxes, and depletion or foreign tax credit with respect to a decedent which are not properly allowable to the decedent with respect to the taxable period in which falls the date of his/her death[xix].
A person who is required to include in his/her gross income for any taxable year an amount of income with respect to a decedent may deduct for the same taxable year that portion of the estate tax imposed upon the decedent’s estate which is attributable to the inclusion in the decedent’s estate of the right to receive such amount[xx].
In the case of an estate or trust, the amount allowed as a deduction is computed by excluding from the gross income of the estate or trust the portion of gross income in respect of a decedent which is properly paid, credited, or to be distributed to the beneficiaries during the taxable year[xxi].
Further, the exemptions provided to an individual are allowed in the case of a decedent’s final returns also. Tax deductions for personal exemptions are not reduced based on shorter tax period of a decedent[xxii]. If the deceased person has contributed more than one-half of a dependent’s annual support, the decedent’s representative can claim a dependency exemption on final returns. However, if a decedent is a dependent of another taxpayer the decedent’s personal exemption is not allowed on his/her final returns filed.
[i] Halliday v. United States, 655 F.2d 68 (5th Cir. Ala. 1981)
[ii] 26 CFR 1.753-1 (b)
[iii] 26 USCS § 736 (b)
[iv] Rev. Rul. 79-340 (I.R.S. 1979)
[v] Bausch’s Estate v. Commissioner, 186 F.2d 313 (2d Cir. 1951)
[vi] Estate of Jack Messing v. Commissioner, 1948 Tax Ct. Memo LEXIS 114 (T.C. 1948)
[vii] Rev. Rul. 78-292 (I.R.S. 1978)
[viii] Hess v. Commissioner, 31 T.C. 165 (T.C. 1958)
[ix] Rev. Rul. 2005-30 (I.R.S. 2005)
[x] 26 CFR 1.83-1
[xi] Halliday v. United States, 655 F.2d 68 (5th Cir. Ala. 1981)
[xii] 26 USCS § 691 (a) (1)
[xiii] 26 USCS § 691(a) (3)
[xiv] 26 CFR 1.691(a)-3
[xv] 26 USCS § 691 (a)
[xvi] 26 CFR 1.691(a)-2 (b)
[xvii] 26 USCS § 6072
[xviii] 26 CFR 1.443-1
[xix] 26 USCS § 691 (b)
[xx] 26 CFR 1.691(c)-1 (a)
[xxi] 26 USCS § 691(c) (1)
[xxii] 26 CFR 1.443-1
Income Tax Issues Related to Decedents: Related Pages
- Character of Income With Respect to Decedents
- Transfers of Rights to Income
- Redemption of U.S. Savings Bonds
- Gain On Property Sold By Decedent During Lifetime
- Individual Retirement Account (IRA) Distributions
- Deductions Related to Decedent
- Computing Income Tax Deductions For Estate Tax
- Generation Skipping Transfers
- Decedent Tax Returns
- Income Includible On Decedent’s Last Tax Return
- Exemptions on Decedent’s Last Tax Return
- Deductions for Decedent’s Medical Expenses