748 / Is the recipient of income in respect of a decedent (IRD) entitled to an income tax deduction for estate and generation-skipping transfer taxes paid on this income?

In technical advice, the IRS stated that the value of a decedent’s IRA should not be discounted for estate tax purposes to reflect income taxes that will be payable by the beneficiaries upon receipt of distributions from the IRAs or for lack of marketability. The Service reasoned that the deduction is a statutory remedy for the adverse income tax impact and makes any valuation discount inappropriate if the deduction applies.⁴ Courts have likewise denied discounts for lack of marketability.⁵ The Service also determined that a deduction claimed on a decedent’s estate tax return – which represented income taxes paid by the estate on the estate’s income tax return, which in turn were triggered by the amount distributed to the estate from the decedent’s IRAs – was not allowable as a deduction under IRC Section 2053. According to the Service, even if the estate had not claimed the IRD deduction, the income taxes paid on the distributions from the IRAs would still not be deductible under IRC Section 2053 because any additional benefit beyond what Congress had intended would be unwarranted.⁶

The Service has ruled 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. If the death benefit is instead received in the form of a series of periodic payments, the amounts received are likewise includible in the beneficiary’s gross income in an amount determined under IRC Section 72 as IRD.⁷ See, e.g., Let. Rul. 200537019 (where the Service ruled that the amount equal to the excess of the contract’s value over the decedent’s basis, which would be received by the estate as the named beneficiary of the contract upon surrender of the contract, would constitute IRD includible by the estate in its gross income; however, the estate would be entitled to a deduction for the amounts of IRD paid to charities in the taxable year, or for the remaining amounts of IRD that would be set aside for charitable purposes).

In Estate of Kahn,⁸ the Tax Court held that in computing the gross estate value, the value of the assets held in the IRAs is not reduced by the anticipated income tax liability following the distribution of IRAs, in part because IRC Section 691(c) addresses the potential double tax issue. The Tax Court further held that a discount for lack of marketability is not warranted because the assets in the IRAs are publicly traded securities. Payment of the tax upon distribution is not a prerequisite to making the assets in the IRA marketable; consequently there is no basis for the discount. In technical advice the Service has also determined that a discount for lack of marketability is not available to an estate where the deduction for IRD is available to mitigate the potential income tax liability triggered by the IRD assets.⁹