This section contains information about the effect of an individual's death on the income tax liability of the survivors (including the widow or widower and the beneficiaries) and the estate. Any survivor should coordinate the filing of his or her own tax return with the personal representative handling the decedent's estate. The personal representative can coordinate filing status, exemptions, income, and deductions so that the final return and the income tax returns of the survivors and the estate are all filed correctly.

Gifts and inheritances. Property received as a gift, bequest, or inheritance is not included in your income. However, if the property you receive in this manner later produces income, such as interest, dividends, or rentals, then that income is taxable to you. If the gift, bequest, or inheritance you receive is the income from property, that income is taxable to you.

If you inherited the right to receive income in respect of the decedent, see Income in Respect of the Decedent, later.

Surviving spouse with dependent child. If there is a dependent child, the surviving spouse may be entitled to use the standard deduction amount and the tax rates that apply to joint returns for the 2 years following the year of the decedent's death. See Qualifying Widow(er) With Dependent Child in chapter 2 for information on how to qualify.

Decedent as your dependent. If the decedent qualified as your dependent for the part of the year before death, you can claim the full exemption amount for the dependent on your tax return.

Income in Respect of the Decedent

All gross income that the decedent had a right to receive and that is not properly includible on the decedent's final return is called income in respect of the decedent. Instead of being reported on the final return of the decedent, the income is included, for the tax year when received, in the gross income of:

1. The decedent's estate, if the estate acquires the right to receive the income from the decedent,
2. The person who acquires the right to the income directly from the decedent without going through the estate, or
3. Any person to whom the estate properly distributes the right to receive the income.

Example 1. Thornton Jones owned and operated an orchard, and he used the cash method of accounting. He sold and delivered $2,000 worth of fruit to a customer, but he did not receive payment before his death. When the estate was settled, payment had still not been made, and the estate gave the right to receive the payment to his niece. When she collects the $2,000, she must include it in her income. It is not reported on the final return of the decedent nor on the estate's income tax return.

Example 2. If, in Example 1, Thornton Jones had used the accrual method of accounting, the income from the fruit sale must be included on his final return. Neither his estate nor his niece will report the income when the money is later paid.

Example 3. Mary Smith was entitled to a large salary payment at the time of her death. It was to be paid in five yearly payments. Her estate, after collecting two payments, distributes the right to the remaining payments to you, the beneficiary. None of the payments would be included on the decedent's final return. The estate must include in its gross income, as income in respect of the decedent, the two payments it received. You must include in your gross income each of the three remaining payments as you receive them.

Transferring your right to income. If you transfer your right to receive income in respect of a decedent, you must include in your income the larger of:

1. The amount you receive for the right, or
2. The fair market value of the right at the time of the transfer.

Fair market value (FMV). FMV is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts.

Giving your right to income as a gift. If you give your right to receive income in respect of a decedent as a gift, you must include in your gross income the fair market value of the right at the time you make the gift.

Type of income. The character, or type, of income that you receive in respect of a decedent is generally the same as it would have been had the decedent continued to live and had received it. For example, if the income would have been a long-term capital gain to the decedent, it will be a long-term capital gain to you.

Interest on certificates of deposit (CDs). Interest on CDs that is not received by the date of death but that is earned between the date of the last interest payment and the date of death is interest income in respect of the decedent. Interest income earned on the account after the decedent's death that becomes payable on CDs after death is not income in respect of a decedent. That interest is ordinary income that belongs to the respective recipients and must be included in their gross income.

Installment payments. If the decedent had sold property using the installment method and you receive the right to collect the payments after the date of death, the payments you collect are income in respect of the decedent. You use the same gross profit percentage that the decedent used to figure the part of each payment that represents profit. Include in your income the same profit the decedent would have included had death not occurred. See Publication 537, Installment Sales, for more information on the installment method.

Sale or exchange. If you sell or exchange an installment obligation that you received from a decedent, the rules explained in Publication 537 for figuring the gain or loss on the disposition apply. However, your basis in the obligation is the same as the decedent's basis, adjusted for all installment payments you received before the sale or exchange.

Medical savings account (MSA). The treatment of an MSA at the death of the account holder depends on who acquires the interest in the account. If the decedent's estate acquired the interest, see the earlier discussion under How to Report Certain Income.

If the decedent's spouse is the designated beneficiary of the MSA, the MSA becomes that spouse's MSA. It is subject to the rules discussed in Publication 969.

Any other beneficiary (including a spouse that is not the designated beneficiary) must include in gross income the fair market value of the assets in the account on the decedent's date of death. This amount must be reported for the beneficiary's tax year that includes the decedent's date of death. The amount included in gross income is reduced by the qualified medical expenses for the decedent that are paid by the beneficiary within 1 year after the decedent's date of death. An estate tax deduction, discussed later, applies to the amount included in income by a beneficiary, other than the decedent's spouse.

Other income. For examples of other income situations concerning decedents, see Specific Types of Income in Respect of a Decedent in Publication 559.

Deductions in Respect of the Decedent

Deductions in respect of the decedent are items, such as business expenses, income-producing expenses, interest, and taxes, for which the decedent was liable but which are not deductible on the decedent's final income tax return. When paid, these expenses can be deducted by:

1. The estate, or
2. If the estate is not liable for the expenses, the person who, because of the decedent's death, acquired the decedent's property subject to that liability.

Federal estate tax deduction. Income that a decedent had a right to receive is included in the decedent's gross estate and is subject to estate tax. This income in respect of a decedent is also taxed when received by the estate or beneficiary. An income tax deduction is allowed to the person (or estate) receiving the income. If you must include in your gross income an amount of income in respect of a decedent, then you can claim a deduction for part of any estate tax paid. The deduction must be claimed in the same tax year that the income is included in your gross income.

You can claim the deduction only as a miscellaneous itemized deduction on Schedule A (Form 1040). This deduction is not subject to the 2% limit on miscellaneous itemized deductions as discussed in chapter 30.

If the income is capital gain income, then in figuring the maximum capital gain tax or any net capital loss limitation, the amount of the gain must be reduced, but not below zero, by the amount of any estate tax deduction attributable to that gain.

For more information, see Estate Tax Deduction in Publication 559.

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