the Probate Judge—Income in Respect of a Decedent
Rudd, appeared October 20, 2005, Albuquerque Journal, Business Outlook
Reprinted with permission
- Editor's note: This
column may not be quoted or reproduced in whole or part without express written
permission of the author.
Q: I have U.S. savings bonds in joint name with my recently deceased mother,
who paid everything into these bonds. My understanding is that the tax liability,
upon redemption, goes against the person who paid in. I am wondering if the
tax liability would go against my mother's estate? J.L., Tijeras
Fair warning, Readers-take a big gulp of coffee before tackling this tantalizing
Generally inheritances are not considered income to the recipient. One important
exception is assets that are tax-deferred or have not yet been taxed, such
as U.S. savings bonds, certain pensions, IRA's and annuities. These assets
do not receive a stepped-up basis at the death of their owner and once these
assets are redeemed or withdrawn by the beneficiaries, the income is considered
"income in respect of a decedent" (IRD).
You hit the nail on the head when you said, "upon redemption." It
is surprising how much interest older bonds earn upon redemption. For example,
a 30-year-old $500 bond can generate over $2,000 in interest income upon redemption.
The answer to your question depends upon who redeems the bonds. In the interest
of good public service, I read large portions of IRS Publication 559, Survivors,
Executors, and Administrators, that addresses this topic. I learned that taxpayers
may defer recognizing the interest on E, EE, and I bonds until the bonds are
cashed; or, alternatively, they may elect to report the accrued interest each
year. Most people choose deference.
The IRD issue can arise when a taxpayer, who has deferred the interest, dies
holding the bonds, as in your case. At this point, the personal representative
may elect to recognize the accrued interest on the decedent taxpayer's final
individual income tax return rather than have the beneficiaries be responsible
for the tax on the interest. Personal representatives who are unfamiliar with
tax laws may not even know they have this choice. This election must be made
by the due date, including extensions, for filing the decedent's final return.
If the election is made, all of the interest earned on the bonds before the
decedent's death would be included on the decedent's income tax return. The
estate or beneficiary would then include on its return only the interest earned
after the date of death.
If an election is not made, the interest earned to the date of death is IRD
and is not included in the decedent's final return. According to Publication
559, IRD must be included in the 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; or
- Any person to whom the
estate properly distributes the right to receive it.
Including the bond income on the decedent's final income tax return may be
the best move for decedents who do not have much income and who may have significant
medical deductions (including long term care costs) in their final year, reducing
their taxable income. Recognizing the interest on the decedent's final tax
return often results in lower total tax than if beneficiaries in higher tax
brackets pay the tax on the interest when the bonds are later cashed. For
large estates on which estate tax will be due, the election may also help
because the income tax due as a result of recognizing the interest on the
decedent's final return reduces the total value of the estate, thereby reducing
the estate tax due.
One way a bond owner can continue to defer income tax liability is not to
redeem the bonds. An owner could leave the unredeemed savings bonds to qualified
charities by will, trust or beneficiary designation. Since qualified charities
usually do not pay income tax, the charity can receive the full benefit of
the U.S. savings bonds upon the owner's death.
For those who choose to redeem the bonds and pay the federal income taxes,
at least in New Mexico, taxpayers do not have to pay state income tax on the
bond interest income.
Publication 559 addresses IRD, as well as many other estate tax topics in
depth. You can read the publication on line at www.irs.gov or call 1-800-829-3676
to request a free copy.
Since I can only give general information in this column, you should consult
a knowledgeable tax attorney or CPA about the best choice for your mother's
Thanks to my CPA friend M.Z. for greatly improving this column.
2005, Albuquerque Journal, All Rights Reserved