Inherited IRAs and the IRD Deduction

Tax News You Can Use | For Professional Advisors

May 5, 2025

Inherited IRAs and the IRD Deduction

It often comes as a surprise to beneficiaries of traditional IRAs that they cannot spend the full balance of the inherited account because of the income tax payable on distributions from the IRA. The surprise can shift quickly to more intense emotions when the traditional IRA was included in an estate subject to estate tax, because estate tax is payable on the full amount of the IRA, including the dollars that will be used to pay the income tax. Why, the beneficiaries may wonder, is there not a reduction in the value of the IRA for estate tax purposes to account for the income tax? The answer is that the income tax consequences are not the same for all beneficiaries — they may be in different marginal income tax brackets or even a tax-exempt entity. However, there is a potential income tax deduction under section 691(c) of the tax code for estate tax paid on items of income in respect of a decedent (IRD), which can avoid the dreaded double taxation.

What is IRD and the IRD Deduction?

IRD usually refers to income that accrued to a person during their lifetime, but which was paid only after they died. The most common large ticket items of IRD are accounts receivable, salary and bonus payments, and taxable distributions from retirement accounts. The IRD income tax deduction allows the beneficiary who receives the IRD to, under certain circumstances, take a deduction for some of the estate tax paid at the decedent’s death. This deduction only applies to items of IRD that were also subject to federal estate tax, so it is not applicable where there was no estate tax paid due to an available exemption or marital or charitable deductions. Items of IRD in which the decedent had basis (such as from after-tax contributions to the IRA that are not taxable upon withdrawal) are not entitled to an income tax deduction for estate taxes paid.

How is the IRD Deduction Calculated?

If a beneficiary receives an item of IRD for which estate tax was paid, the beneficiary has ordinary income in the year in which the IRD is received and can take a deduction for the amount of estate tax attributable to that IRD item. To compute the IRD deduction, a pro forma estate tax calculation is made to determine what the estate tax would have been if none of the IRD were included in the decedent’s taxable estate. That number is subtracted from the actual estate tax paid to determine the amount of estate tax attributable to the inclusion of the IRD item(s) in the estate.¹ If the IRD is received by several persons or is received in several payments, the estate tax attributable to the inclusion of IRD items in the estate is allocated pro rata among them.

Example:

Let’s look at an example with a traditional IRA.

Daniel was a resident of Florida and died in 2025, leaving an estate worth $30 million that included a $2 million traditional IRA. Daniel was 78 at the time of his death. His spouse, Melanie, predeceased him in 2025.She had not paid any estate tax and had elected to pass on all of her estate and gift tax exemption to Daniel. The IRA named Daniel’s child, Sam (aged 45 at Daniel’s death), a resident of California, as the sole beneficiary. Sam is not disabled or chronically ill, so, for required minimum distribution (RMD) purposes, the 10-year rule applies.

Daniel’s federal estate tax (there is no Florida estate tax) is $808,000, taking into account both Daniel’s and Melanie’s exemptions. If the $2 million traditional IRA were not included in Daniel’s estate for estate tax purposes, the estate tax would have been only $8,000, so the estate tax attributable to the inclusion of the traditional IRA in Daniel’s estate is $800,000. Because Daniel died after his required beginning date, Sam is required to take RMDs from the IRA each year based on Sam’s age, and then Sam must withdraw all the assets from the IRA no later than the end of the tenth year after Daniel’s death.

The chart below shows the RMDs from Sam’s inherited IRA, the portion of the IRD deduction allocated to each year’s RMD, and Sam’s income tax on the RMDs based on a combined 50% state and federal income tax rate, taking into account the IRD deduction. This assumes that there is a 5% annual investment return on assets inside the IRA² and that RMDs are taken in January with a final withdrawal of the balance at the end of year 10.

Numbers have been rounded to the nearest whole digit. In this example, our beneficiary, Sam, saves $400,000 in income tax due to the availability of the IRD deduction. In addition, due to the states of residence of Daniel and Sam, the marginal income tax rate of 50% is higher than the estate tax rate of 40% on amounts in excess of the exemption.

Does Every IRA Beneficiary Get an IRD Deduction?

An IRD deduction is only available where the beneficiary receives IRD, the IRD is subject to income tax, and the IRD itself generated estate tax. This means that there are a number of common situations where an IRD deduction is not available. These include:

• Roth IRAs and retirement plans where withdrawals are not subject to income tax (e.g., the Roth was established by contribution or rollover more than 5 years before the withdrawal). There is no income tax, so there is no IRD deduction.
• IRAs payable to charities, because they are exempt from income tax and were probably not subject to estate tax due to the unlimited charitable deduction.
• IRAs payable to U.S. citizen surviving spouses, because those are not subject to estate tax due to the unlimited marital deduction.
• IRAs where the decedent’s available exclusion resulted in no estate tax due.
• Taxpayers who claim the standard deduction, because the IRD deduction is a miscellaneous itemized deduction and is not available to taxpayers who do not itemize their deductions.

How Does a Taxpayer Claim the IRD Deduction?

The IRD deduction is a miscellaneous itemized deduction not subject to the 2% floor. It is claimed on line 16 of Schedule A of the taxpayer’s 1040.

What If a Taxpayer was Unaware of the Availability of the IRD Deduction?

A taxpayer who was eligible to claim a deduction under 691(c) but failed to do so may file a corrected form 1040-X to claim the deduction for open years (generally up to three years after the due date for the original return).