A Low-Cost Way to Leave a Lasting Legacy

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With tax season behind us, it’s time to assist clients in their tax planning. For that reason, I felt it timely to discuss the IRD — I had one of my largest tax clients, and a good friend, surprised by this when his father passed away last year.

When an individual passes away, it’s almost certain that there’ll be a piece of his or her estate that can be taxed at a rate of almost 100%. It’s a little thing known as “income in respect of a decedent,” better known as IRD. It’s almost certain that you will have it in your estate — but your heirs may not see one thin dime of it. But the good news is that IRD can be used to make a charitable gift that can leave a lasting legacy.

What’s IRD? Basically, IRD is income that was owed to an individual upon death. It can include unpaid salary, most deferred-compensation arrangements (e.g., IRAs, employer-provided retirement and pension plans), accrued interest on bonds, previously untaxed appreciation in Series E savings bonds and similar government bonds.

The income is not included on the individual’s pre-death income tax return. But it gets hit with a multiple-tax whammy. How? IRD is subject to estate tax and income tax when it’s in the hands of the heirs (however, an income tax deduction for the federal estate tax paid is allowed to the taxpayer who has to include the IRD in gross income). With a top state and federal estate tax rate of 55% and a top income tax rate of 39.6%, the effective rate of overall taxation on IRD is around 80%. But when you pile on other possible taxes — extra death taxes in certain states, generation-skipping transfer taxes, state and local income taxes — the tax rate on IRD could approach 100%.

What to do:  Consider giving the IRD items that will wind up in an estate to charity instead of having it all go to the tax man. A gift to charity of IRD items will generally avoid the tough estate and income tax treatment these amounts receive. This can be structured as an outright bequest.

Important: Charitable gifts that involve IRD items must be structured just right to achieve the desired tax benefits. If it’s a large amount you may want to suggest that the client see an attorney.

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