Publication 559 |
2000 Tax Year |
Other Tax Information
This section contains information about the effect of an
individual's death on the income tax liability of the survivors
(including widows and widowers), the beneficiaries, and the estate.
Tax Benefits for Survivors
Survivors can qualify for certain benefits when filing their own
income tax returns.
Joint return by surviving spouse.
A surviving spouse can file a joint return for the year of death
and may qualify for special tax rates for the following 2 years, as
explained under Qualifying widows and widowers, later.
Decedent as your dependent.
If the decedent qualified as your dependent for the part of the
year before death, you can claim the exemption for the dependent on
your tax return, regardless of when death occurred during the year.
If the decedent was your qualifying child, you may be able to claim
the child tax credit.
Qualifying widows and widowers.
If your spouse died within the 2 tax years preceding the year for
which your return is being filed, you may be eligible to claim the
filing status of qualifying widow(er) with dependent child and qualify
to use the Married filing jointly tax rates.
Requirements.
Generally, you qualify for this special benefit if you meet all of
the following requirements.
- You were entitled to file a joint return with your spouse
for the year of death -- whether or not you actually filed
jointly.
- You did not remarry before the end of the current tax
year.
- You have a child, stepchild, or foster child who qualifies
as your dependent for the tax year.
- You provide more than half the cost of maintaining your
home, which is the principal residence of that child for the entire
year except for temporary absences.
Example.
William Burns's wife died in 1998. Mr. Burns has not remarried and
continued throughout 1999 and 2000 to maintain a home for himself and
his dependent child. For 1998 he was entitled to file a joint return
for himself and his deceased wife. For 1999 and 2000, he qualifies to
file as a "Qualifying widow(er) with dependent child." For later
years, he may qualify to file as a head of household.
Figuring your tax.
Include only your own income, exemptions, and deductions in
figuring your tax, but check the box on line 5 (Form 1040 or 1040A)
under filing status on your tax return and enter the year of death in
the parentheses. Use the Tax Rate Schedule or the column in the Tax
Table for Married filing jointly, which gives you the
split-income benefits.
The last year you can file jointly with, or claim an exemption for,
your deceased spouse is the year of death.
Joint return filing rules.
If you are the surviving spouse and a personal representative is
handling the estate for the decedent, you should coordinate filing
your return for the year of death with this personal representative.
See Joint Return earlier under Final Return for
Decedent.
Income in Respect
of the Decedent
All gross income that the decedent would have received had death
not occurred, that was not properly includible on the final return,
discussed earlier, is income in respect of the decedent.
How To Report
Income in respect of a decedent must be included in the gross
income of one of the following.
- The decedent's estate, if the estate receives it.
- The beneficiary, if the right to income is passed directly
to the beneficiary and the beneficiary receives it.
- Any person to whom the estate properly distributes the right
to receive it.
If you have to include income in respect of the decedent in your
gross income, you may be able to claim a deduction for the estate tax
paid on that income. See Estate Tax Deduction, later.
Example 1.
Frank Johnson owned and operated an apple orchard. He used the cash
method of accounting. He sold and delivered 1,000 bushels of apples to
a canning factory for $2,000, but did not receive payment before his
death. The proceeds from the sale are income in respect of the
decedent. When the estate was settled, payment had not been made and
the estate transferred the right to the payment to his widow. When
Frank's widow collects the $2,000, she must include that amount in her
return. It is not reported on the final return of the decedent nor on
the return of the estate.
Example 2.
Assume Frank Johnson used the accrual method of accounting in
Example 1. The amount accrued from the sale of the apples
would be included on his final return. Neither the estate nor the
widow will realize income in respect of the decedent when the money is
later paid.
Example 3.
On February 1, George High, a cash method taxpayer, sold his
tractor for $3,000, payable March 1 of the same year. His adjusted
basis in the tractor was $2,000. Mr. High died on February 15, before
receiving payment. The gain to be reported as income in respect of the
decedent is the $1,000 difference between the decedent's basis in the
property and the sale proceeds. In other words, the income in respect
of the decedent is the gain the decedent would have realized had he
lived.
Example 4.
Cathy O'Neil was entitled to a large salary payment at the date of
her death. The amount was to be paid in five annual installments. The
estate, after collecting two installments, distributed the right to
the remaining installments to you, the beneficiary. The payments are
income in respect of the decedent. None of the payments were
includible on Cathy's final return. The estate must include in its
gross income the two installments it received, and you must include in
your gross income each of the three installments as you receive them.
Example 5.
You inherited the right to receive renewal commissions on life
insurance sold by your father before his death. You inherited the
right from your mother, who acquired it by bequest from your father.
Your mother died before she received all the commissions she had the
right to receive, so you received the rest. The commissions are income
in respect of the decedent. None of these commissions were includible
in your father's final return. The commissions received by your mother
were included in her gross income. The commissions you received are
not includible in your mother's gross income, even on her final
return. You must include them in your income.
Character of income.
The character of the income you receive in respect of a decedent is
the same as it would have been to the decedent if he or she were
alive. If the income would have been a capital gain to the decedent,
it will be a capital gain to you.
Transfer of right to income.
If you transfer your right to income in respect of a decedent, you
must include in your income the greater of:
- The amount you receive for the right, or
- The fair market value of the right you transfer.
If you make a gift of such a right, you must include in your gross
income the fair market value of the right at the time of the gift.
If the right to income from an installment obligation is
transferred, the amount you must include in income is reduced by the
basis of the obligation. See Installment obligations,
later.
Transfer defined.
A transfer for this purpose includes a sale, exchange, or other
disposition, the satisfaction of an installment obligation at other
than face value, or the cancellation of an installment obligation.
Installment obligations.
If the decedent had sold property using the installment method and
you collect payments on an installment obligation you acquired from
the decedent, use the same gross profit percentage the decedent used
to figure the part of each payment that represents profit. Include in
your income the same profit the decedent would have included had death
not occurred. For more information, see Publication 537,
Installment Sales.
If you dispose of an installment obligation acquired from a
decedent (other than by transfer to the obligor), the rules explained
in Publication 537
for figuring gain or loss on the disposition apply
to you.
Transfer to obligor.
A transfer of a right to income, discussed earlier, has occurred if
the decedent (seller) had sold property using the installment method
and the installment obligation is transferred to the obligor (buyer or
person legally obligated to pay the installments). A transfer also
occurs if the obligation is canceled either at death or by the estate
or person receiving the obligation from the decedent. An obligation
that becomes unenforceable is treated as having been canceled.
If such a transfer occurs, the amount included in the income of the
transferor (the estate or beneficiary) is the greater of the amount
received or the fair market value of the installment obligation at the
time of transfer, reduced by the basis of the obligation. The basis of
the obligation is the decedent's basis, adjusted for all installment
payments received after the decedent's death and before the transfer.
If the decedent and obligor were related persons, the fair market
value of the obligation cannot be less than its face value.
Specific Types of Income
in Respect of a Decedent
This section explains and provides examples of some specific types
of income in respect of a decedent.
Wages.
The entire amount of wages or other employee compensation earned by
the decedent but unpaid at the time of death is income in respect of
the decedent. The income is not reduced by any amounts withheld by the
employer when paid to the estate or other beneficiary. If the income
is $600 or more, the employer should report it in box 3 of Form
1099-MISC and give the recipient a copy of the form or a similar
statement.
Wages paid as income in respect of a decedent are not subject to
federal income tax withholding. However, if paid during the calendar
year of death, they are subject to withholding for social security and
Medicare taxes. These taxes should be included on the decedent's Form
W-2 with the taxes withheld before death. These wages are not
included in box 1 of Form W-2.
Wages paid as income in respect of a decedent after the year of
death generally are not subject to withholding for any federal taxes.
Farm income from crops, crop shares, and livestock.
A farmer's growing crops and livestock at the date of death would
not normally give rise to income in respect of a decedent or income to
be included in the final return. However, when a cash method farmer
receives rent in the form of crop shares or livestock and owns the
crop shares or livestock at the time of death, the rent is income in
respect of a decedent and is reported in the year in which the crop
shares or livestock are sold or otherwise disposed of. The same
treatment applies to crop shares or livestock the decedent had a right
to receive as rent at the time of death for economic activities that
occurred before death.
If the individual died during a rental period, only the proceeds
from the portion of the rental period ending with death are income in
respect of a decedent. The proceeds from the portion of the rental
period from the day after death to the end of the rental period are
income to the estate. Cash rent or crop shares and livestock received
as rent and reduced to cash by the decedent are includible in the
final return even though the rental period did not end until after
death.
Example.
Alonzo Roberts, who used the cash method of accounting, leased part
of his farm for a 1-year period beginning March 1. The rental was
one-third of the crop, payable in cash when the crop share is sold at
the direction of Roberts. Roberts died on June 30 and was alive during
122 days of the rental period. Seven months later, Roberts' personal
representative ordered the crop to be sold and was paid $1,500. Of the
$1,500, 122/365, or $501, is income in respect of a decedent. The
balance of the $1,500 received by the estate, $999, is income to the
estate.
Partnership income.
If the partner who died had been receiving payments representing a
distributive share or guaranteed payment in liquidation of the
partner's interest in a partnership, the remaining payments made to
the estate or other successor in interest are income in respect of the
decedent. The estate or the successor receiving the payments must
include them in gross income when received. Similarly, the estate or
other successor in interest receives income in respect of a decedent
if amounts are paid by a third person in exchange for the successor's
right to the future payments.
For a discussion of partnership rules, see Publication 541,
Partnerships.
U.S. savings bonds acquired from decedent.
If series EE or series I U.S. savings bonds that were owned by a
cash method individual who had chosen to report the interest each year
(or by an accrual method individual) are transferred because of death,
the increase in value of the bonds (interest earned) in the year of
death up to the date of death must be reported on the decedent's final
return. The transferee (estate or beneficiary) reports on its return
only the interest earned after the date of death.
The redemption values of U.S. savings bonds generally are available
from local banks, savings and loan institutions, or your nearest
Federal Reserve Bank.
You also can get information by writing to the following address.
Bureau of the Public Debt
P.O. Box 1328
Parkersburg, WV 26106-1328
Or, on the Internet, visit the following site.
www.publicdebt.treas.gov
If the bonds transferred because of death were owned by a cash
method individual who had not chosen to report the interest each year
and had purchased the bonds entirely with personal funds, interest
earned before death must be reported in one of the following ways.
- The person (executor, administrator, etc.) who must file the
final income tax return of the decedent can elect to
include in it all of the interest earned on the bonds before the
decedent's death. The transferee (estate or beneficiary) then includes
in its return only the interest earned after the date of death.
- If the election in (1), above, was not made, the interest
earned to the date of death is income in respect of the decedent and
is not included in the decedent's final return. In this case, all of
the interest earned before and after the decedent's death is income to
the transferee (estate or beneficiary). A transferee who uses the cash
method of accounting and who has not chosen to report the interest
annually may defer reporting any of it until the bonds are cashed or
the date of maturity, whichever is earlier. In the year the interest
is reported, the transferee may claim a deduction for any federal
estate tax paid that arose because of the part of interest (if any)
included in the decedent's estate.
Example 1.
Your uncle, a cash method taxpayer, died and left you a $1,000
series EE bond. He had bought the bond for $500 and had not chosen to
report the increase in value each year. At the date of death, interest
of $94 had accrued on the bond, and its value of $594 at date of death
was included in your uncle's estate. Your uncle's personal
representative did not choose to include the $94 accrued interest in
the decedent's final income tax return. You are a cash method taxpayer
and do not choose to report the increase in value each year as it is
earned. Assuming you cash it when it reaches maturity value of $1,000,
you would report $500 interest income (the difference between maturity
value of $1,000 and the original cost of $500) in that year. You also
are entitled to claim, in that year, a deduction for any federal
estate tax resulting from the inclusion in your uncle's estate of the
$94 increase in value.
Example 2.
If, in Example 1, the personal representative had chosen
to include the $94 interest earned on the bond before death in the
final income tax return of your uncle, you would report $406 ($500
- $94) as interest when you cashed the bond at maturity. Since
this $406 represents the interest earned after your uncle's death and
was not included in his estate, no deduction for federal estate tax is
allowable for this amount.
Example 3.
Your uncle died owning series HH bonds that he acquired in exchange
for series EE bonds. You were the beneficiary on these bonds. Your
uncle used the cash method of accounting and had not chosen to report
the increase in redemption price of the series EE bonds each year as
it accrued. Your uncle's personal representative made no election to
include any interest earned before death in the decedent's final
return. Your income in respect of the decedent is the sum of the
unreported increase in value of the series EE bonds, which constituted
part of the amount paid for series HH bonds, and the interest, if any,
payable on the series HH bonds but not received as of the date of the
decedent's death.
Specific dollar amount legacy satisfied by transfer of bonds.
If you receive series EE or series I bonds from an estate in
satisfaction of a specific dollar amount legacy and the decedent was a
cash method taxpayer who did not elect to report interest each year,
only the interest earned after you receive the bonds is your income.
The interest earned to the date of death plus any further interest
earned to the date of distribution is income to (and reportable by)
the estate.
Cashing U.S. savings bonds.
When you cash a U.S. savings bond that you acquired from a
decedent, the bank or other payer that redeems it must give you a Form
1099-INT if the interest part of the payment you receive is $10
or more. Your Form 1099-INT should show the difference between
the amount received and the cost of the bond. The interest shown on
your Form 1099-INT will not be reduced by any interest reported
by the decedent before death, or, if elected, by the personal
representative on the final income tax return of the decedent, or by
the estate on the estate's income tax return. Your Form 1099-INT
may show more interest than you must include in your income.
You must make an adjustment on your tax return to report the
correct amount of interest. See Publication 550,
Investment
Income and Expenses, for information about the correct reporting
of this interest.
Interest accrued on U.S. Treasury bonds.
The interest accrued on U.S. Treasury bonds owned by a cash method
taxpayer and redeemable for the payment of federal estate taxes that
was not received as of the date of the individual's death is income in
respect of the decedent. This interest is not included in the
decedent's final income tax return. The estate will treat such
interest as taxable income in the tax year received if it chooses to
redeem the U.S. Treasury bonds to pay federal estate taxes. If the
person entitled to the bonds by bequest, devise, or inheritance, or
because of the death of the individual (owner) receives them, that
person will treat the accrued interest as taxable income in the year
the interest is received. Interest that accrues on the U.S. Treasury
bonds after the owner's death does not represent income in respect of
the decedent. The interest, however, is taxable income and must be
included in the gross income of the respective recipients.
Interest accrued on savings certificates.
The interest accrued on savings certificates (redeemable after
death without forfeiture of interest) that is for the period from the
date of the last interest payment and ending with the date of the
decedent's death, but not received as of that date, is income in
respect of a decedent. Interest for a period after the decedent's
death that becomes payable on the certificates after death is not
income in respect of a decedent, but is taxable income includible in
the gross income of the respective recipients.
Inherited IRAs.
If a beneficiary receives a lump-sum distribution from a
traditional IRA or a Roth IRA he or she inherited, all or some of it
may be taxable. The distribution is taxable in the year received as
income in respect of a decedent up to the decedent's taxable balance.
This is the decedent's balance at the time of death, including
unrealized appreciation and income accrued to date of death, minus any
basis (nondeductible contributions). Amounts distributed that are more
than the decedent's entire IRA balance (includes taxable and
nontaxable amounts) at the time of death are the income of the
beneficiary. See Roth IRA, next, for determining taxability
of Roth IRA distributions.
If the beneficiary of a traditional IRA is the decedent's surviving
spouse and that spouse properly rolls over the distribution into
another traditional IRA or to a Roth IRA, the distribution is not
currently taxed.
Example 1.
At the time of his death, Greg owned a traditional IRA. All of the
contributions by Greg to the IRA had been deductible contributions.
Greg's nephew, Mark, was the sole beneficiary of the IRA. The entire
balance of the IRA, including income accruing before and after Greg's
death, was distributed to Mark in a lump sum. Mark must include the
total amount received in his gross income. The portion of the lump-sum
distribution that equals the amount of the balance in the IRA at
Greg's death, including the income earned before death, is income in
respect of the decedent. Mark may take a deduction for any federal
estate taxes that were paid on the portion of the IRA that is income
in respect of the decedent.
Example 2.
Assume the same facts as in Example 1, except some of Greg's
contributions to the IRA had been nondeductible contributions. To
determine the amount to include in gross income, Mark must subtract
the total nondeductible contributions made by Greg from the total
amount received (including the income that was earned in the IRA both
before and after Greg's death). Income in respect of the decedent is
the total amount included in gross income less the income earned after
Greg's death.
For more information on inherited IRAs, see Publication 590.
Roth IRA.
Qualified distributions from a Roth IRA are not subject to tax. A
distribution made 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 5-taxable-year period beginning with the first tax year
in which a contribution was made to any Roth IRA of the owner.
A distribution cannot be a qualified distribution unless it is made
after 2002.
Generally, the entire interest in the Roth IRA must be distributed
by the end of the fifth calendar year after the year of the owner's
death unless the interest is payable to a designated beneficiary over
his or her life or life expectancy. If paid as an annuity, the
distributions must begin before the end of the calendar year following
the year of death. If the sole beneficiary is the decedent's spouse,
the spouse can delay the distributions until the decedent would have
reached age 70 1/2 or can treat the Roth IRA as his or her
own Roth IRA.
A portion of a distribution to a beneficiary that is not a
qualified distribution may be includible in the beneficiary's gross
income. Generally, the portion includible is the earnings in the
decedent's Roth IRAs. Earnings attributable to the period ending with
the decedent's date of death are income in respect of the decedent.
Additional taxable amounts are the income of the beneficiary.
For more information on Roth IRAs, see Publication 590.
Education IRA.
Generally, the balance in an education individual retirement
account (education IRA) must be distributed within 30 days after the
individual for whom the account was established reaches age 30 or
dies, whichever is earlier. The treatment of the education IRA at the
death of an individual under age 30 depends on who acquires the
interest in the account. If the decedent's estate acquires the
interest, see the discussion under Final Return for Decedent,
earlier.
If the decedent's spouse or other family member is the designated
beneficiary of the decedent's account, the education IRA becomes that
person's education IRA. It is subject to the rules discussed in
Publication 590.
Any other beneficiary (including a spouse or family member that is
not the designated beneficiary) must include in gross income the
earnings portion of the distribution. The distribution must be made
within 30 days. Any balance remaining at the close of the 30-day
period is deemed to be distributed at that time. The amount included
in gross income is reduced by any qualified higher education expenses
of the decedent that are paid by the beneficiary within 1 year after
the decedent's date of death. An estate tax deduction, discussed
later, applies to the amount included in income by a beneficiary other
than the decedent's spouse or family member.
Medical savings account (MSA).
The treatment of an MSA, including a Medicare+ Choice MSA, at the
death of the account holder depends on who acquires the interest in
the account. If the decedent's estate acquired the interest, see the
discussion under Final Return for Decedent, earlier.
If the decedent's spouse is the designated beneficiary of the MSA,
the MSA becomes that spouse's MSA. It is subject to the rules
discussed in Publication 969.
Any other beneficiary (including a spouse that is not the
designated beneficiary) must include in gross income the fair market
value of the assets in the account on the decedent's date of death.
This amount must be reported for the beneficiary's tax year that
includes the decedent's date of death. The amount included in gross
income is reduced by the qualified medical expenses for the decedent
that are paid by the beneficiary within 1 year after the decedent's
date of death. An estate tax deduction, discussed later, applies to
the amount included in income by a beneficiary, other than the
decedent's spouse.
Deductions in Respect
of the Decedent
Items such as business expenses, income-producing expenses,
interest, and taxes, for which the decedent was liable but which are
not properly allowable as deductions on the decedent's final income
tax return, will be allowed as a deduction when paid to one of the
following.
- The estate.
- 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.
Similar treatment is given to the foreign tax credit. A beneficiary
who must pay a foreign tax on income in respect of a decedent will be
entitled to claim the foreign tax credit.
Depletion.
The deduction for percentage depletion is allowable only to the
person (estate or beneficiary) who receives income in respect of the
decedent to which the deduction relates, whether or not that person
receives the property from which the income is derived. An heir who
(because of the decedent's death) receives income as a result of the
sale of units of mineral by the decedent (who used the cash method)
will be entitled to the depletion allowance for that income. If the
decedent had not figured the deduction on the basis of percentage
depletion, any depletion deduction to which the decedent was entitled
at the time of death would be allowable on the decedent's final
return, and no depletion deduction in respect of the decedent would be
allowed to anyone else.
For more information about depletion, see chapter 10 in Publication 535,
Business Expenses.
Estate Tax Deduction
Income that a decedent had a right to receive is included in the
decedent's gross estate and is subject to estate tax. This income in
respect of a decedent is also taxed when received by the recipient
(estate or beneficiary). However, an income tax deduction is allowed
to the recipient for the estate tax paid on the income.
The deduction for estate tax can be claimed only for the same tax
year in which the income in respect of the decedent must be included
in the recipient's gross income. (This also is true for income in
respect of a prior decedent.)
Individuals can claim this deduction only as an itemized deduction,
on line 27 of Schedule A (Form 1040). This deduction is not
subject to the 2% limit on miscellaneous itemized deductions.
Estates can claim the deduction on the line provided for the deduction
on Form 1041. For the alternative minimum tax computation, the
deduction is not included in the itemized deductions that are an
adjustment to taxable income.
If the income in respect of the decedent is capital gain income,
you must reduce the gain, but not below zero, by any deduction for
estate tax paid on such gain. This applies in figuring the following.
- The maximum tax on net capital gain.
- The 50% exclusion for gain on small business stock.
- The limitation on capital losses.
Computation
To figure a recipient's estate tax deduction, determine--
- The estate tax that qualifies for the deduction, and
- The recipient's part of the deductible tax.
Deductible estate tax.
The estate tax is the tax on the taxable estate, reduced by any
credits allowed. The estate tax qualifying for the deduction is the
part for the net value of all the items in the estate that represent
income in respect of the decedent. Net value is the excess
of the items of income in respect of the decedent over the items of
expenses in respect of the decedent. The deductible estate tax is the
difference between the actual estate tax and the estate tax determined
without including net value.
Example 1.
Jack Sage used the cash method of accounting. At the time of his
death, he was entitled to receive $12,000 from clients for his
services and he had accrued bond interest of $8,000, for a total
income in respect of the decedent of $20,000. He also owed $5,000 for
business expenses for which his estate is liable. The income and
expenses are reported on Jack's estate tax return.
The tax on Jack's estate is $9,460 after credits. The net value of
the items included as income in respect of the decedent is $15,000
($20,000 - $5,000). The estate tax determined without including
the $15,000 in the taxable estate is $4,840, after credits. The estate
tax that qualifies for the deduction is $4,620 ($9,460 -
$4,840).
Recipient's deductible part.
Figure the recipient's part of the deductible estate tax by
dividing the estate tax value of the items of income in respect of the
decedent included in the recipient's gross income (the numerator) by
the total value of all items included in the estate that represents
income in respect of the decedent (the denominator). If the amount
included in the recipient's gross income is less than the estate tax
value of the item, use the lesser amount in the numerator.
Example 2.
As the beneficiary of Jack's estate (Example 1), you
collect the $12,000 accounts receivable from his clients. You will
include the $12,000 in your gross income in the tax year you receive
it. If you itemize your deductions in that tax year, you can claim an
estate tax deduction of $2,772 figured as follows:
explained computation
numerical computation
If the amount you collected for the accounts receivable was more
than $12,000, you would still claim $2,772 as an estate tax deduction
because only the $12,000 actually reported on the estate tax return
can be used in the above computation. However, if you collected less
than the $12,000 reported on the estate tax return, use the smaller
amount to figure the estate tax deduction.
Estates.
The estate tax deduction allowed an estate is figured in the same
manner as just discussed. However, any income in respect of a decedent
received by the estate during the tax year is reduced by any such
income that is properly paid, credited, or required to be distributed
by the estate to a beneficiary. The beneficiary would include such
distributed income in respect of a decedent for figuring the
beneficiary's deduction.
Surviving annuitants.
For the estate tax deduction, an annuity received by a surviving
annuitant under a joint and survivor annuity contract is considered
income in respect of a decedent. The deceased annuitant must have died
after the annuity starting date. You must make a special computation
to figure the estate tax deduction for the surviving annuitant. See
section 1.691(d)-1 of the regulations.
Gifts, Insurance,
and Inheritances
Property received as a gift, bequest, or inheritance is not
included in your income. But if property you receive in this manner
later produces income, such as interest, dividends, or rentals, that
income is taxable to you. The income from property donated to a trust
that is paid, credited, or distributed to you is taxable income to
you. If the gift, bequest, or inheritance is the income from property,
that income is taxable to you.
If you receive property from a decedent's estate in satisfaction of
your right to the income of the estate, it is treated as a bequest or
inheritance of income from property. See Distributions to
Beneficiaries From an Estate, later.
Insurance
The proceeds from a decedent's life insurance policy paid by reason
of his or her death generally are excluded from income. The exclusion
applies to any beneficiary, whether a family member or other
individual, a corporation, or a partnership.
Veterans' insurance proceeds.
Veterans' insurance proceeds and dividends are not taxable either
to the veteran or to the beneficiaries.
Interest on dividends left on deposit with the Department of
Veterans Affairs is not taxable.
Life insurance proceeds.
Life insurance proceeds paid to you because of the death of the
insured (or because the insured is a member of the U.S. uniformed
services who is missing in action) are not taxable unless the policy
was turned over to you for a price. This is true even if the proceeds
are paid under an accident or health insurance policy or an endowment
contract. If the proceeds are received in installments, see the
discussion under Insurance received in installments, later.
Accelerated death benefits.
You can exclude from income accelerated death benefits you receive
on the life of an insured individual if certain requirements are met.
Accelerated death benefits are amounts received under a life insurance
contract before the death of the insured. These benefits also include
amounts received on the sale or assignment of the contract to a
viatical settlement provider. This exclusion applies only if the
insured was a terminally ill individual or a chronically ill
individual. This exclusion does not apply if the insured is a
director, officer, employee, or has a financial interest in any trade
or business carried on by you.
Terminally ill individual.
A terminally ill individual is one who has been certified by a
physician as having an illness or physical condition that can
reasonably be expected to result in death in 24 months or less from
the date of certification.
Chronically ill individual.
A chronically ill individual is one who has been certified as one
of the following.
- An individual who, for at least 90 days, is unable to
perform at least two activities of daily living without substantial
assistance due to a loss of functional capacity.
- An individual who requires substantial supervision to be
protected from threats to health and safety due to severe cognitive
impairment.
A certification must have been made by a licensed health care
practitioner within the previous 12 months.
Exclusion limited.
If the insured was a chronically ill individual, your exclusion of
accelerated death benefits is limited to the cost you incurred in
providing qualified long-term care services for the insured. In
determining the cost incurred do not include amounts paid or
reimbursed by insurance or otherwise. Subject to certain limits, you
can exclude payments received on a periodic basis without regard to
your costs.
Insurance received in installments.
If you receive life insurance proceeds in installments, you can
exclude part of each installment from your income.
To determine the part excluded, divide the amount held by the
insurance company (generally the total lump sum payable at the death
of the insured person) by the number of installments to be paid.
Include anything over this excluded part in your income as interest.
Specified number of installments.
If you will receive a specified number of installments under the
insurance contract, figure the part of each installment you can
exclude by dividing the amount held by the insurance company by the
number of installments to which you are entitled. A secondary
beneficiary, in case you die before you receive all of the
installments, is entitled to the same exclusion.
Example.
As beneficiary, you choose to receive $40,000 of life insurance
proceeds in 10 annual installments of $6,000. Each year, you can
exclude from your gross income $4,000 ($40,000 x 10) as a
return of principal. The balance of the installment, $2,000, is
taxable as interest income.
Specified amount payable.
If each installment you receive under the insurance contract is a
specific amount based on a guaranteed rate of interest, but the number
of installments you will receive is uncertain, the part of each
installment that you can exclude from income is the amount held by the
insurance company divided by the number of installments necessary to
use up the principal and guaranteed interest in the contract.
Example.
The face amount of the policy is $200,000, and as beneficiary you
choose to receive annual installments of $12,000. The insurer's
settlement option guarantees you this amount for 20 years based on a
guaranteed rate of interest. It also provides that extra interest may
be credited to the principal balance according to the insurer's
earnings. The excludable part of each guaranteed installment is
$10,000 ($200,000 x 20 years). The balance of each guaranteed
installment, $2,000, is interest income to you. The full amount of any
additional payment for interest is income to you.
Installments for life.
If, as the beneficiary under an insurance contract, you are
entitled to receive the proceeds in installments for the rest of your
life without a refund or period-certain guarantee, you figure the
excluded part of each installment by dividing the amount held by the
insurance company by your life expectancy. If there is a refund or
period-certain guarantee, the amount held by the insurance company for
this purpose is reduced by the actuarial value of the guarantee.
Example.
As beneficiary, you choose to receive the $50,000 proceeds from a
life insurance contract under a "life-income-with-cash-refund
option." You are guaranteed $2,700 a year for the rest of your life
(which is estimated by use of mortality tables to be 25 years from the
insured's death). The actuarial value of the refund feature is $9,000.
The amount held by the insurance company, reduced by the value of the
guarantee, is $41,000 ($50,000 - $9,000) and the excludable part
of each installment representing a return of principal is $1,640
($41,000 x 25). The remaining $1,060 ($2,700 - $1,640) is
interest income to you. If you should die before receiving the entire
$50,000, the refund payable to the refund beneficiary is not taxable.
Interest option on insurance.
If an insurance company pays you interest only on proceeds from
life insurance left on deposit, the interest you are paid is taxable.
Flexible premium contracts.
A life insurance contract (including any qualified additional
benefits) is a flexible premium life insurance contract if it provides
for the payment of one or more premiums that are not fixed by the
insurer as to both timing and amount. For contracts issued before
January 1, 1985, the proceeds paid because of the death of the insured
under a flexible premium contract will be excluded from the
recipient's gross income only if the contracts meet the requirements
explained under section 101(f) of the Internal Revenue Code.
Basis of Inherited Property
Your basis in property you inherit from a decedent is generally one
of the following.
- The fair market value (FMV) of the property at the date of
the individual's death.
- The FMV on the alternate valuation date (discussed in the
instructions for Form 706), if so elected by the personal
representative for the estate.
- The value under the special-use valuation method for real
property used in farming or other closely held business (see
Special-use valuation, later), if so elected by the
personal representative.
- The decedent's adjusted basis in land to the extent of the
value that is excluded from the decedent's taxable estate as a
qualified conservation easement (discussed in the instructions for
Form 706).
Exception for appreciated property.
If you or your spouse gave appreciated property to an
individual during the 1-year period ending on the date of that
individual's death and you (or your spouse) later acquired the same
property from the decedent, your basis in the property is the same as
the decedent's adjusted basis immediately before death.
Appreciated property.
Appreciated property is property that had an FMV on the day it was
transferred to the decedent greater than its adjusted basis.
Special-use valuation.
If you are a qualified heir and you receive a farm
or other closely held business real property from the estate for
which the personal representative elected special-use valuation, the
property is valued on the basis of its actual use rather than its FMV.
If you are a qualified heir and you buy special-use valuation
property from the estate, your basis is the estate's basis (determined
under the special-use valuation method) immediately before your
purchase increased by any gain recognized by the estate.
You are a qualified heir if you are an ancestor (parent,
grandparent, etc.), the spouse, or a lineal descendant (child,
grandchild, etc.) of the decedent, a lineal descendant of the
decedent's parent or spouse, or the spouse of any of these lineal
descendants.
For more information on special-use valuation, see Form 706.
Increased basis for special-use valuation property.
Under certain conditions, some or all of the estate tax benefits
obtained by using the special-use valuation will be subject to
recapture. Generally, an additional estate tax must be paid by the
qualified heir if within 10 years of the decedent's death the property
is disposed of, or is no longer used for a qualifying purpose.
If you must pay any additional estate (recapture) tax, you can
elect to increase your basis in the special-use valuation property to
its FMV on the date of the decedent's death (or on the alternate
valuation date, if it was elected by the personal representative). If
you elect to increase your basis, you must pay interest on the
recapture tax for the period from the date 9 months after the
decedent's death until the date you pay the recapture tax.
For more information on the recapture tax, see Instructions
for Form 706-A.
S corporation stock.
The basis of inherited S corporation stock must be reduced if there
is income in respect of a decedent attributable to that stock.
Joint interest.
Figure the surviving tenant's new basis of property that was
jointly owned (joint tenancy or tenancy by the entirety) by adding the
surviving tenant's original basis in the property to the value of the
part of the property (one of the values described earlier) included in
the decedent's estate. Subtract from the sum any deductions for wear
and tear, such as depreciation or depletion, allowed to the surviving
tenant on that property.
Example.
Fred and Anne Maple (brother and sister) owned, as joint tenants
with right of survivorship, rental property they purchased for
$60,000. Anne paid $15,000 of the purchase price and Fred paid
$45,000. Under local law, each had a half interest in the income from
the property. When Fred died, the FMV of the property was $100,000.
Depreciation deductions allowed before Fred's death were $20,000.
Anne's basis in the property is $80,000 figured as follows:
Anne's original basis |
$15,000 |
Interest acquired from Fred ( 3/4
of $100,000) |
75,000 |
$90,000 |
Minus: 1/2 of $20,000
depreciation |
10,000 |
Anne's basis |
$80,000 |
Qualified joint interest.
One-half of the value of property owned by a decedent and spouse as
tenants by the entirety, or as joint tenants with right of
survivorship if the decedent and spouse are the only joint tenants, is
included in the decedent's gross estate. This is true regardless of
how much each contributed toward the purchase price.
Figure the basis for a surviving spouse by adding one-half of the
property's cost basis to the value included in the gross estate.
Subtract from this sum any deductions for wear and tear, such as
depreciation or depletion, allowed on that property to the surviving
spouse.
Example.
Dan and Diane Gilbert owned, as tenants by the entirety, rental
property they purchased for $60,000. Dan paid $15,000 of the purchase
price and Diane paid $45,000. Under local law, each had a half
interest in the income from the property. When Diane died, the FMV of
the property was $100,000. Depreciation deductions allowed before
Diane's death were $20,000. Dan's basis in the property is $70,000
figured as follows:
One-half of cost basis ( 1/2 of
$60,000) |
$30,000 |
Interest acquired from Diane ( 1/2
of $100,000) |
50,000 |
$80,000 |
Minus: 1/2 of $20,000
depreciation |
10,000 |
Dan's basis |
$70,000 |
More information.
See Publication 551,
Basis of Assets, for more
information on basis. If you and your spouse lived in a community
property state, see the discussion in that publication about figuring
the basis of your community property after your spouse's death.
Depreciation.
If you can depreciate property you inherited, you generally must
use the modified accelerated cost recovery system (MACRS) to determine
depreciation.
For joint interests and qualified joint interests, you must make
the following computations to figure depreciation.
- The first computation is for your original basis in the
property.
- The second computation is for the inherited part of the
property.
Continue depreciating your original basis under the same method
you had used in previous years. Depreciate the inherited part using
MACRS.
For more information on MACRS, see Publication 946,
How To
Depreciate Property.
Substantial valuation misstatement.
If the value or adjusted basis of any property claimed on an income
tax return is 200% or more of the amount determined to be the correct
amount, there is a substantial valuation misstatement. If this
misstatement results in an underpayment of tax of more than $5,000, an
addition to tax of 20% of the underpayment can apply. The penalty
increases to 40% if the value or adjusted basis is 400% or more of the
amount determined to be the correct amount. If the value shown on the
estate tax return is overstated and you use that value as your basis
in the inherited property, you could be liable for the addition to
tax.
The IRS may waive all or part of the addition to tax if you have a
reasonable basis for the claimed value. The fact that the adjusted
basis on your income tax return is the same as the value on the estate
tax return is not enough to show that you had a reasonable basis to
claim the valuation.
Holding period.
If you sell or dispose of inherited property that is a capital
asset, you have a long-term gain or loss from property held for more
than 1 year, regardless of how long you held the property.
Property distributed in kind.
Your basis in property distributed in kind by a decedent's estate
is the same as the estate's basis immediately before the distribution
plus any gain, or minus any loss, recognized by the estate. Property
is distributed in kind if it satisfies your right to receive another
property or amount, such as the income of the estate or a specific
dollar amount. Property distributed in kind generally includes any
noncash property you receive from the estate other than the following.
- A specific bequest (unless it must be distributed in more
than three installments).
- Real property, the title to which passes directly to you
under local law.
For information on an estate's recognized gain or loss on
distributions in kind, see Income To Include under
Income Tax Return of an Estate- Form 1041, later.
Other Items of Income
Some other items of income that you, as a survivor or beneficiary,
may receive are discussed below. Lump-sum payments you receive as the
surviving spouse or beneficiary of a deceased employee may represent
accrued salary payments; distributions from employee profit-sharing,
pension, annuity, and stock bonus plans; or other items that should be
treated separately for tax purposes. The treatment of these lump-sum
payments depends on what the payments represent.
Public safety officers.
Special rules apply to certain amounts received because of the
death of a public safety officer (police and law enforcement officers,
fire fighters, ambulance crews, and rescue squads).
Death benefits.
The death benefit payable to eligible survivors of public safety
officers who die as a result of traumatic injuries sustained in the
line of duty is not included in either the beneficiaries' income or
the decedent's gross estate. The benefit is administered through the
Bureau of Justice Assistance (BJA).
The BJA can pay the eligible survivors an emergency interim benefit
up to $3,000 if it determines that a public safety officer's death is
one for which a death benefit will probably be paid. If there is no
final payment, the recipient of the interim benefit is liable for
repayment. However, the BJA may waive all or part of the repayment if
it will cause a hardship. If all or part of the repayment is waived,
that amount is not included in gross income.
Survivor benefits.
Generally, a survivor annuity paid to the spouse, former spouse, or
child of a public safety officer killed in the line of duty is
excluded from the recipient's gross income. The annuity must be
provided under a government plan and is excludable to the extent that
it is attributable to the officer's service as a public safety
officer.
The exclusion does not apply if the recipient's actions were
responsible for the officer's death. It also does not apply in the
following circumstances.
- The death was caused by the intentional misconduct of the
officer or by the officer's intention to cause such death.
- The officer was voluntarily intoxicated at the time of
death.
- The officer was performing his or her duties in a grossly
negligent manner at the time of death.
This provision applies to officers dying after 1996.
Salary or wages.
Salary or wages paid after the employee's death are usually taxable
income to the beneficiary. See Wages, earlier, under
Specific Types of Income in Respect of a Decedent.
Lump-sum distributions.
You may be able to choose optional methods to figure the tax on
lump-sum distributions from qualified employee retirement plans. For
more information, see Publication 575,
Pension and Annuity
Income.
Pensions and annuities.
For beneficiaries of deceased employees who receive pensions and
annuities, see Publication 575.
For beneficiaries of federal Civil
Service employees, see Publication 721,
Tax Guide to U.S. Civil
Service Retirement Benefits.
Inherited IRAs.
If a person other than the decedent's spouse inherits the
decedent's traditional IRA or Roth IRA, that person cannot treat the
IRA as one established on his or her behalf. If a distribution from a
traditional IRA is from contributions that were deducted or from
earnings and gains in the IRA, it is fully taxable income. If there
were nondeductible contributions, an allocation between taxable and
nontaxable income must be made. For information on distributions from
a Roth IRA, see the discussion earlier under Income in Respect of
the Decedent. The IRA cannot be rolled over into, or receive a
rollover from, another IRA. No deduction is allowed for amounts paid
into that inherited IRA. For more information about IRAs, see
Publication 590.
Estate income.
Estates may have to pay federal income tax. Beneficiaries may have
to pay tax on their share of estate income. However, there is never a
double tax. See Distributions to Beneficiaries From an Estate,
later.
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