Thursday April 25, 2024

3.2.3 Bequests of IRAs and Other IRD Assets

Bequests of IRAs and Other IRD Assets

Income in Respect of a Decedent:   Some assets transferred to heirs do not receive a stepped-up basis.

Bequest of IRD:   IRD assets are an excellent choice for transfer to charities.

Transfer of IRD Assets:   IRD assets are frequently transferred through a beneficiary designation.

Income in Respect of a Decedent

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.

Common IRD assets include IRAs and pension plans, the ordinary element within a commercial annuity, stock options, unqualified deferred compensation, the gain in installment notes and the ordinary element within U.S. savings bonds.

Bequest of IRD

IRD assets are an excellent choice for transfer to charities. While the IRD asset may have been a very desirable asset for the decedent, given a choice, the heirs would far prefer a capital asset to an IRD asset. The capital asset receives a stepped-up basis and the heir may convert the capital asset to cash with no recognition of capital gain. However, upon recognizing the ordinary income or capital gain in the IRD asset, the heir will be subject to tax. Thus, it is eminently logical to transfer capital assets such as stock or land to heirs and use IRD assets for charitable transfers.

When the IRD asset is transferred to charity, the exempt charity will receive the asset without payment of income tax. The IRD asset is a passive asset and thus generates no unrelated business taxable income. Sec. 512. In addition, the transfer to a charity qualifies for an estate tax charitable deduction. Sec. 2055(a).

Transfer of IRD Assets

IRD assets are frequently transferred through a beneficiary designation. A custodian or trustee administers the IRA or pension plan. This is in essence a contractual relationship. In the contract between the IRA owner and the custodian, there will be an opportunity for a beneficiary designation. Normally, it is possible to select both a primary beneficiary and a contingent beneficiary. When the IRA owner passes away, the transfer is not made under the terms of the will of the decedent, but rather in accordance with the beneficiary designation in the contract.

Pension plans and commercial annuities also may be transferred through a beneficiary designation. Savings bonds can be transferred through a pay-on-death provision. In addition, the estate may receive options, installment notes and other types of IRD.

If distributions are made to charity from the probate estate, it is very beneficial to have an allocation provision that permits the executor to use the IRD in satisfaction of charitable bequests. However, caution should be exercised not to require use of IRD assets for pecuniary bequests, since satisfying a pecuniary bequest with IRD could trigger recognition of ordinary income at the estate level.

Case Studies on Bequests of IRAs and Other IRD Assets

IRD Assets Make Better Bequests:   James Johnson passed away two years ago and in his will he made various pre-residuary property bequests. He then left the estate's residue in various percentages to a number of tax-exempt charities. In total, the percentage of the residual to be transferred to the charities was 25%, representing approximately $500,000 of value. The will gave the executor, Jeffrey Nelson, the power to sell any assets or to distribute assets in-kind. Among the assets in the decedent's residuary estate were Series E bonds and Series HH bonds that had accrued reportable income. James had not elected under Code Sec. 454(a) to report the bond interest annually and, therefore, the accrued interest on the bonds is income in respect of a decedent (IRD). Generally, the interest is treated as includable in the decedent's estate and is taxable either to the decedent, the estate or estate beneficiaries. However, since neither James nor his estate elected to report the increase in the bonds' redemption price each year as it accrued (nor did the estate intend to do so), the beneficiaries of the estate would be required to report the accrued interest when the bonds are redeemed.

Martha's New Vows and New IRA Beneficiaries:   Martha Smith was a true delight to the people who knew her. A theater performer for over 50 years, Martha definitely knew how to entertain. Even at the age of 85, she continued to amaze people with her abundant energy and love for life. In fact, when she had moved into an assisted-living facility at age 78, she organized a dinner theater production with the local residents. Their performances received wonderful praise from family and employees alike. Martha had truly become a glorious part of her new home.

The Philandering Philanthropist, Part 1 of 4 - IRA to Charity:   John Doe, 77, is a self-made man. Deserted by his parents at a young age, John grew up in a boys' home and on the streets. At the age of 17, he moved to Texas to chase oil and women. With his street smarts and gritty determination, John made millions in the oil business as an arrogant and risk-taking maverick. His fortune with women, however, was not nearly as successful. In fact, John was married - and divorced - four times. To this day, John still claims it was "all their fault" and remains bitter toward his ex-wives. Yet, he continues to date and currently has several "girlfriends." Also, John has six children, but unfortunately, does not have any ongoing relationship with them. He contends that his children are spoiled and ungrateful because he gave them too much while they were growing up. More likely, John's poor relationships stem from the lack of any family structure in his youth and the minimal amount of support given to him as a child.

Private Letter Rulings

PLR 199939039 IRA to Private Foundation:   Taxpayer created and funded a private foundation, subject to the IRC Secs. 4941-4948 private foundation rules. He now desires to name the private foundation as designated beneficiary of his IRAs and pension plans. Taxpayer requests rulings that the income in respect of a decedent (IRD) will be deductible in his estate but will not be taxable as unrelated business income (UBI) to the private foundation and that the proceeds will be excluded from the 2% tax on private foundation investment income.

PLR 200002011 Unqualified Deferred Comp and Options Bequeathed to Charity:   Taxpayer has accrued a right to three different types of unqualified deferred compensation. He has compensation that has been payable but has been deferred, non-statutory stock options that he may exercise and a right of his estate to receive an additional amount of nonqualified deferred compensation.

PLR 200012076 Bequest of Nonqualified Options IRD to Charity:   Senior officers of technology companies and other corporations frequently receive stock options as part of their compensation. The taxpayer in this ruling is the retired chairman of Company X and holds vested nonqualified stock options that will expire in 15 years.

PLR 200221011 Taxpayer's IRA Beneficiary Designation Produces IRD to Estate:   Taxpayer's estate consisted of an IRA and various other assets. Taxpayer named her estate as the beneficiary of her IRA. Taxpayer also created a will providing that specific bequests be given to certain individuals and charities at her death. Once the specific bequests were completed, the residue of Taxpayer's estate would be distributed to qualified charitable organizations.

PLR 200234019 Executor's Post-Death Assignment of IRAs to Charity Allowed:   Decedent's estate contained three IRAs and four qualified annuities. Decedent named her estate as the beneficiary of all of these retirement accounts. Upon her death, Decedent's will directed that her estate be given to certain named individuals and certain named charities. Decedent's executor had the power to allocate assets to beneficiaries and make cash or in-kind distributions.

PLR 200452004 IRAs and Annuities Allocated to Charity:   IRAs and deferred annuity contracts benefit from tax-deferred growth. While funds are held in the IRA or annuity contract, they may grow tax-free. However, in nearly all cases, distributions to beneficiaries require recognition of ordinary income.

PLR 200537019 IRD Includible in Decedent's Estate, but not Taxable:   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.

PLR 200803002 Commercial Annuity Allocated Tax-free to Charity:   X created Trust to distribute Trust assets upon X's death with Charities receiving a portion each of the residue. X also owned a non-qualified deferred annuity contract (Annuity) and designated Trust as the beneficiary.

PLR 200848020 IRA Charitable Transfer - No Sec. 642(c) Deduction:   In ILM 200848020 (28 Jul 2008), the Service denied an income tax deduction under Sec. 642(c) for a distribution to charity from an IRA testamentary trust.

PLR 200905016 Deduction Permitted for Deferred Compensation Plan Benefiting Charity:   Employer adopted a nonqualified deferred compensation plan for employees. The plan permitted employees to defer a portion of their salary and incentive compensation.

PLR 201247023 ORG's Defined Benefit Plan Deemed a Church Plan:   Taxpayer A is recognized as a religious tax-exempt organization under Sec. 501(c)(3). Taxpayer A is listed in Directory S, which is the official listing of entities of related organizations whose mission is to further the objectives of Church A.

PLR 201308033 Religious Org's Benefits Plan a Church Plan:   Employer establishes Religion R educational institutions. It prepares students to become Religion R clerics, religious teachers and communal service workers and is the sole seminary for Religion R.
PLR 201350048 Religious Org's Benefits Plans Are Church Plans:   The Community is a tax-exempt entity and a member of another exempt entity, Foundation B. Six members of Community's board are elected by Foundation B, which is the sole member of Community.

Related Topics on Bequests of IRAs and Other IRD Assets

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.

3.11.4  IRA to Testamentary Unitrust:    During life, an IRA is an excellent asset. It grows tax free, the minimum withdrawals under the regulations are fairly modest and it provides both retirement income and liquidity for the IRA owner. However, for the children or other individual heirs of the IRA owner, the IRA is not nearly as desirable an asset.

3.11.5  Stretch Unitrust with IRA:    Many articles have been written advocating the economic advantages of a Stretch IRA. The Stretch IRA allows the designated beneficiary to receive distributions over his or her lifetime. While there may be substantial estate tax, the tax-free growth inside the IRA will produce an excellent income stream for the beneficiary.

3.2.2  Estate Tax Deductions:    Transfers from a taxable estate will qualify for an estate tax charitable deduction, so long as they benefit a qualified exempt charity or the entity is "operated exclusively for religious, charitable, scientific, literary or educational purposes." Sec. 2055(a)(2). In addition to the domestic qualified exempt charities listed in IRS Pub. 78, foreign charities may also qualify for an estate tax (but not an income tax) charitable deduction. The foreign gift must expressly limit the use to the "exclusively charitable" purposes listed above. Reg. 20.2055-1(a)(4). See also Rev. Rul. 74-523.

      Quiz-Basic



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