Even within the context of a tax code filled with a seemingly endless and unnecessarily complicated supply of liabilities, exemptions, and loopholes, some taxes are particularly insidious in their ability to surprise an unwary taxpayer. One such “stealth tax,” as I refer to taxes that are particularly difficult to identify or isolate, is called Income in Respect of a Decedent (IRD).
If an item of income received by a decedent’s estate would have been taxed as ordinary income if the decedent had received it while still alive, it is IRD. The assets most commonly affected are retirement plans such as IRAs, 401(k)s, 403(b)s, and 457s.
Unknown to Most Taxpayers
Many taxpayers have never heard of IRD because their financial advisors have not advised them about this tax. Perhaps this is because it could affect the desire of taxpayers to contribute to retirement plans. Additionally, many may have a perception that issues related to IRD should be planned for later in life rather than sooner. However, not considering this aspect of the income tax can be disastrous to future heirs.
73% Tax Rate?
This is because IRD is taxed under both the income and estate tax. That is, the total fair market value of assets is included in your estate and also included in the final income tax return at death. The following is an example that illustrates how disastrous this “stealth tax” can be:
Assume a gross estate of $5 Million and a taxable estate of $4 Million is left to beneficiaries. The estate has a $2 Million Traditional IRA and a $1 Million §401(k). Assuming an Estate Tax of 55% and an Income Tax rate of 40%, at death the tax result would be as follows.
- Estate Value: $3,000,000 x .55 = $1,650,000 in Estate Tax
- Total Income: $3,000,000 x .40 = $540,000 in Income Tax
- Total Taxes on IRD Items: $2,190,000 (73% Effective Rate )
As you can see, from a $5 million gross estate ($4 million taxable estate – $1 million sheltered from the estate tax), the total amount going to loved ones would only be $1.81 million. Many of us think that we have not named the government as a beneficiary to our estate, but this table tells a very different story.
By understanding the basic nature of the IRD tax, you can ask your financial advisor, CPA, and tax attorney the right questions to best protect you and your family from this stealth tax that can dramatically diminish the amount your beneficiaries receive.
Yee Law Group, PC: Sacramento and Roseville Area Tax Attorneys
The lack of sound tax planning can cost you; the lack of trusted and experienced tax counsel can cost you even more. At Yee Law Group, PC, we use our deep knowledge of domestic and international tax law to our clients’ advantage, and work closely with them to put them in the strongest position to keep tax liabilities, and tax authorities, at bay. If you’d like to discuss your tax questions or concerns, please give us a call at (916) 599-7297. We look forward to the privilege of being your attorneys.