* CPAs MUST EXERCISE CAUTION TO CAPTURE CORRECT income in respect of the decedent (IRD) deductions on clients' returns. Since clients typically don't understand the issue well enough to volunteer the existence of IRD, CPAs must make sure they ask clients the right questions to elicit the information they need to prepare a return.
* ONE OF THE CRITICAL TAX-COMPLIANCE ISSUES CPAs help their clients with is the proper reporting of IRD--income a decedent is entitled to at the time of his or her death but which is not properly includible on any federal income tax re turn. It also includes income triggered by reason of death, including IRA distributions.
* WHILE IRD IS TAXABLE TO A BENEFICIARY WHEN he or she receives it, the law permits the beneficiary to deduct any estate taxes attributable to the income. This itemized deduction is not subject to the 2% of adjusted gross income limitation. Beneficiaries who do not itemize get no deduction.
* THE COURTS DISAGREE AS TO HOW TO HANDLE certain types of IRD. This is particularly true for income to which the deceased had no enforceable right, such as a discretionary bonus paid following death. CPAs should be aware different circuit courts of appeal have had different approaches as well.
* IRD RETAINS THE CHARACTER IT WOULD HAVE HAD in the decedent's hands--for example, income that would have been Long-term capital gain to the decedent is taxed as such to the recipient. CPAs can calculate the estate tax attributable to IRD using the "net value" concept. In the case of multiple beneficiaries, each recipient can deduct his or her proportionate share of the tax.
A Wall Street Journal report addressed the value of income in respect of the decedent (IRD) as an income tax deduction. The report said the combined effects of practitioners' not realizing a client's income item constituted IRD and not knowing how to handle the deduction made the treatment of IRD on tax returns "probably the most prevalent error today with respect to estate taxes." This article briefly reviews the concept of income in respect of the decedent, explains IRD application issues resulting from the integration of the federal estate tax and income tax systems and suggests ways CPAs can avoid missing the IRD deduction.
THE IMPORTANCE OF ACCURACY
Many CPA firms maintain tax practices that address compliance issues. According to a national survey by the Texas Society of CPAs, tax services were the source of 48% to 52% of all lees. One primary area of practitioner concern relates to obtaining the information necessary to properly prepare a client's tax return. To help eliminate possible mistakes and omissions, CPAs need to use special diligence in gathering information.
Once thought to be relatively obscure, IRD deductions are becoming more common. Big-ticket IRD items such as distributions from IRAs, 401(k)s, 403(b)s and other tax-sheltered retirement plans of affluent baby boomers have been growing in past decades and will be worth millions when owners bequeath them to estate beneficiaries. Distributions from these plans constitute gross income to the beneficiary and could be subject to marginal federal in come tax rates as high as 35%. Plan balances also are subject to estate tax rates as high as 48%--a double whammy. Together, these taxes can severely reduce the size of a beneficiary's inheritance.