Tuesday, April 23, 2024
GiftLaw Pro
GiftLaw Note: Decedent's will provided gifts of cash and personal property to certain named individuals. The residue of the estate was to be divided equally among 10 named charitable organizations. The will granted the executor the power to make distributions or divisions of the estate in cash or in kind. The executor was also granted the power to give different kinds or disproportionate shares of property or undivided interests in the estate property to the named beneficiaries. Included in decedent's property on his date of death was a non-qualified annuity. The beneficiary of the annuity was the decedent's estate. The estate surrendered the annuity contract. The amount received for the surrender will be distributed to the named charitable beneficiaries. Must the estate include the gain in the surrendered annuity in the estate's taxable income and is it taxed on that amount? The Service held that the income was includible in the estate as income in respect of the decedent (IRD), but the estate would receive a 100% deduction for the amounts that were distributed to the charities or permanently set aside for charitable purposes.

Editor's Note: If a donor is going to make a bequest to charity and that donor has any IRD assets, it is more beneficial for the donor to list the charity or charities as the designated beneficiary of the IRD assets. If the charity is listed as the designated beneficiary, the IRD assets avoid probate. More importantly, a direct transfer of IRD to charity or a charitable trust does not produce taxable income for the estate.
This letter responds to a letter dated June 13, 2003, and subsequent correspondence, submitted by you as the executor of the Estate, requesting certain rulings under the Internal Revenue Code.

The information submitted states that X died on D1 of Year 1. Pursuant to X's will, the executor of the Estate will give certain bequests of cash and personal property to individual named beneficiaries. Any residual estate remaining is to be divided equally and distributed to ten named charitable organizations, each of which is represented as being an organization described in ' 501(c)(3) (collectively, the Charities).

Article VIII of X's will grants the executor of the Estate the power to make distribution or division of the Estate in cash or in kind, or both; to allot different kinds or disproportionate shares of property or undivided interests in property among the beneficiaries, and to determine the value of any such property; and to make such elections under the tax laws applicable to the Estate as the executor determines should be made. No compensating adjustments between principal and income, nor with respect to any bequest or devise, shall be made even though the elections so made may affect (beneficially or adversely) the interests of the beneficiaries.

At the time of X's death, X owned a non-qualified annuity contract (the Contract), which had a basis in X's hands of $ x and a value of $ y as of D1 of Year 1. The Contract was purchased after October 21, 1979. No payments had been received by X under the Contract. The named beneficiary of the death benefit under the Contract is the Estate. The Estate surrendered the Contract on D2 of Year 1 for $ z. The difference between $ y and $ z represents interest accrued after the death of X. The Estate has not included any amount in its gross income or taken any income tax deduction with respect to the Contract for any taxable year. The Estate has made interim distributions satisfying all specific and pecuniary bequests. The amounts received upon surrender of the Contract will be distributed as part of the remaining residuary bequest to the Charities, which have also received interim cash distributions.

The Estate has filed its income tax returns for all taxable years on a fiscal year ending D1, which is not the last day of any month.

Section 441(a) provides that taxable income shall be computed on the basis of the taxpayer's taxable year. In general, an estate may adopt a calendar year or a fiscal year. Section 441(e) defines a fiscal year as a period of twelve months ending on the last day of any month other than December.

Section 642(c)(1) provides that in the case of an estate, there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in ' 170(c) (determined without regard to section 170(c)(2)(A)).

Section 642(c)(2) provides that in the case of an estate, there shall be allowed as a deduction in computing its taxable income any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, permanently set aside for a purpose specified in section 170(c), or is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance, or operation of a public cemetery not operated for profit.

Section 691(a)(1) provides that the amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of the decedent's death or a prior period (including the amount of all items of gross income in respect of a prior decedent, if the right to receive such amount was acquired by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent) shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent; (B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or (C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.

Rev. Rul. 2005-30, 2005-20 I.R.B. 1015, holds that if the owner-annuitant of a deferred annuity contract dies before the annuity starting date, and the beneficiary receives a death benefit under the annuity contract, the amount received by the beneficiary in a lump sum in excess of the owner-annuitant's investment in the contract is includible in the beneficiary's gross income as IRD within the meaning of section 691. Rev. Rul. 2005-30 applies to deferred annuity contracts purchased on or after October 21, 1979.

Based solely on the facts and representations submitted, we conclude that the excess of $ y over $ x received by the Estate (as the named beneficiary of the Contract) upon the surrender of the Contract was IRD includible by the Estate in its Year 1 gross income. The Estate is entitled to a deduction under section 642(c)(1) for the amounts of IRD paid to the Charities in the Year 1 taxable year, or under section 642(c)(2) for the remaining amounts of IRD which were set aside for charitable purposes. We further conclude that the Estate has not filed its income tax returns based on an allowable taxable year under section 441.

The Estate must file amended income tax returns for all taxable years based upon an allowable taxable year. Those returns, as amended, must include the IRD in the Estate's gross income and claim the appropriate deduction under section 642(c). A copy of this letter should be attached to each return.

Except as specifically set forth above, no opinion is expressed concerning the federal tax consequences of the transactions described above.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Sincerely,

J. Thomas Hines, Chief, Branch 2
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Related Topics On IRD Includible in Decedent's Estate, but not Taxable

1.3.3  Charitable Estate Deductions:    A full charitable deduction is permitted for a bequest of cash or property to a charity. Sec. 2055(a). The transfer to charity may be through a specific bequest of a particular asset or a percentage of the whole estate or of the residue. It is essential that the designation be made to a qualified exempt charity.


3.2.3  Bequests of IRAs and Other IRD Assets:    Some assets transferred to heirs do not receive a stepped-up basis. This "income in respect of a decedent" (IRD) is defined as gross income "not properly includable in computing [decedent's] taxable income for the taxable year ending with the date of his death." Reg. 1.691(a)-1(b). IRD assets are those in which there is either untaxed ordinary income or a deferral of capital gain. When the beneficiary receives the asset, the beneficiary is subject to taxation on the asset, just as the original owner would have been subject to such taxation if he or she had recognized the income or gain.


4.11.3  Transfers at Death:    As a general estate and income tax planning strategy, decedents should give "good assets" to family and "bad assets" to charity. Good assets include stocks, real estate and cash. These assets do not generate an income tax liability to an estate or family and, in fact, receive a step up in basis at the decedent's death.



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