Inherited IRA – Estate Tax deduction

Submitted by Scott Walecka on Sun, 2008-10-19 23:39

My wife inherited an IRA from her father’s estate which was in the 45% estate tax bracket. It would be nice if she were not double taxed on the inherited IRA. However it looks like the gross DRD for the estate is larger than the gross IRD. (largely due to state income taxes). Is it true that even though there is no DRD specifically related to the IRA that the gross DRD being larger than the gross IRD eliminates any IRD deduction for my wife on our return when she takes a distribution??



Submitted by Al Fry on Mon, 2008-10-20 01:25

The calculation is fairly simple. One calulates the Federal estate tax on the estate, as filed on the 706. Then the IRA is removed and the calcuation is redone. The difference should be the IRD deduction, however it should be done by the client’s tax professional.



Submitted by Scott Walecka on Mon, 2008-10-20 15:38

Al,

I really like your answer. Its not clear its the same answer I am getting from the guys preparing the 706. Lets take a simplified example. Lets assume the estate consists of $5,000,000 in cash and a $500,000 IRA. Lets assume that the only DRD in the estate is $600,000 of state income tax that was not claimed on the federal income tax return. The guys preparing the 706 say the net IRD used to calculate the overall estate tax deduction is 0 since $600,000 > $500,000. This seems to be implied by the 559 instructions as well.

http://www.irs.gov/publications/p559/ar02.html#d0e1790

Your response implies that I could pull a $225,000 difference (45% of 500K) out of the 706 instr. table A. Their response is that we get no estate tax deduction.

Some discussions I have read online state that only RELATED DRD is used to calculate net IRD. Others seem to think ALL DRD is used in the net IRD calculation.

Do you know which it is?



Submitted by charles lore on Tue, 2008-10-21 01:21

Id like to weigh in on this but I dont understand your lingo.What is DRD?

In the seemingly infinite texts and pubs Ive read on planning ive never come across it. IRD a million times but DRD?



Submitted by mk foss on Tue, 2008-10-21 02:05

DRD stands for “deductions in respect of a decedent” – almost the opposite of IRD. The DRD are deductions claimed both for income tax and estate tax purposes. These items are usually found in Schedule K of the estate tax return – they are debts rather than administration expenses.

Income taxes and interest are the major items of DRD.



Submitted by Scott Walecka on Tue, 2008-10-21 02:09

Chuck,

IRS Pub 559 defines DRD as:

Deductions in Respect of a Decedent

Items such as business expenses, income-producing expenses, interest, and taxes, for which the decedent was liable but that are not properly allowable as deductions on the decedent’s final income tax return will be allowed as a deduction to one of the following when paid:

The estate or

The person who acquired an interest in the decedent’s property (subject to such obligations) because of the decedent’s death, if the estate was not liable for the obligation.

________________________________________________________
What I am being told is that the estate tax deduction is based on net IRD for the estate which is defined to be IRD – DRD unless DRD>IRD in which case it is 0.

I found a fairly good explanation at

http://www.nysscpa.org/cpajournal/2005/905/essentials/p40.htm

I’m only finding passing comments that net IRD = IRD-DRD.
I wish I could find something definitive.

Please let me know what you think,

Thanks,
Scott



Submitted by Al Fry on Tue, 2008-10-21 02:18

However this would apparently not include debts or other items the decedant would not have paid (or deducted) on his income tax return if he had lived to file it.



Submitted by Alan Spross on Tue, 2008-10-21 02:36

Deductions with respect to a decedent. This is described on p 11 of Pub 559 and the resulting treatment on p 12. There are examples showing some DRD, but they do not exceed the IRD amounts as is the case here.

However, the examples do seem to indicate that there will be no IRD deduction if the net value is -0- or negative when IRD assets are reduced by DRD amounts. That seems logical since the DRD deductions are also passed through to the beneficiaries which would reduce the taxes they pay on the IRD to some extent.

Bottom line, the 706 guys appear to be correct. Now, if these people do not do 706s as a routine part of their business, perhaps this should be looked at again.

But – I could be wrong, so Chuck, feel free to explore this further.



Submitted by Scott Walecka on Tue, 2008-10-21 05:33

Alan,

Thanks for the response. Before the death of my father-in-law I never heard of an inherited IRA. In researching inherited IRAs I stumbled across
Ed Slott’s article that gave me hope that I would get a big 45% IRD deduction which seemed to be the implication from his overly simplified article/example. Glad I found the article. Too bad it doesn’t work for me.

http://money.cnn.com/2000/08/23/pensions/retire_slott/index.htm

This was the first time I heard about IRD and the IRD Deduction. The first time I heard about DRD was when I asked the guys filling out the estate tax what the IRD Deduction would be for the inherited IRA. Rather than being 45% of the IRA they said it would be 0 given the amount of overall DRD in the estate. (they have been dealing with IRD/DRD/706s for over 20 years) Oh well. Time to move on.

Thanks everyone for the help.

Scott



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