The Deduction Almost Nobody Claims: §691(c)

If the person who left you the IRA had a taxable estate, you are owed a deduction that no form will tell you about. Claim it.

The problem it fixes is genuine double taxation. A pre-tax retirement account is income in respect of a decedent (IRD) under IRC §691, “Recipients of income in respect of decedents”: it was never taxed to the decedent, so it does not receive a basis step-up under IRC §1014, and the beneficiary pays full ordinary income tax on every dollar. But that same account was also counted at face value in the gross estate and taxed again at 40%. Congress’s partial remedy is IRC §691(c): the beneficiary may deduct the portion of the federal estate tax attributable to the IRD, taken as an itemized deduction that is not subject to the 2% floor and survives the suspension of miscellaneous itemized deductions.

The mechanics are a ratio. Compute the estate tax twice—once as filed, and once with the IRD removed from the gross estate—and the difference is the deductible amount, allocated across beneficiaries in proportion to the IRD each receives and claimed as they recognize the income:

Take a $5 million IRA inside an estate whose marginal estate-tax rate is 40%. Roughly $2 million of estate tax is attributable to that account, so the beneficiary carries a $2 million deduction to be claimed pro rata as the account is emptied over ten years—$200,000 of deduction against each $500,000 of distribution. For a beneficiary at a 37% federal marginal rate, that is about $740,000 of income tax that would otherwise have been paid on money the estate had already been taxed on.

Three practical notes. The deduction belongs to whoever recognizes the income, not to the estate, so the executor must tell the beneficiaries the IRD figure—ask for it in writing during administration, because five years later nobody will reconstruct it. It applies only where federal estate tax was actually paid; an estate under the $15 million exemption generates no deduction, which is most estates and precisely why the rule is so widely forgotten by the preparers who do encounter a taxable one. And it is not limited to retirement accounts—accrued but unpaid salary, deferred compensation, installment-sale receivables, and unpaid partnership distributions are all IRD and all carry the same deduction.