Here is a scenario that plays out tens of thousands of times every year: a parent dies, leaves a $2 million traditional IRA to their adult children, and the children dutifully report each distribution on their tax returns. What almost no one tells them is that a sizable chunk of that IRA was already taxed once at the estate level, and the Internal Revenue Code grants them a separate income tax deduction to offset that double hit. The deduction is not a credit, it is not subject to the 2% adjusted gross income floor that kneecaps most miscellaneous deductions, and it survives the alternative minimum tax. It is called the Section 691(c) deduction for income in respect of a decedent, and roughly half the beneficiaries who qualify for it never claim it.
This guide explains who qualifies, how to calculate the deduction, what counts as "income in respect of a decedent" in the first place, and the small handful of moves that can rescue tens or even hundreds of thousands of dollars in unnecessary tax.
The Double-Tax Problem That Section 691 Solves
When a person dies owning most kinds of property, the heirs receive a fresh tax basis equal to the asset's fair market value on the date of death. This "step-up in basis" under Section 1014 wipes out unrealized appreciation. A taxable brokerage account with a $400,000 cost basis and a $1 million date-of-death value passes to the heirs with a $1 million basis. If they sell the next day, there is no capital gain.
But certain assets do not get a stepped-up basis. They carry the same character of income they would have produced in the decedent's hands. Distributions from a traditional IRA are still ordinary income. Final paychecks owed but unpaid at death are still wages. Installment note payments are still gain plus interest. Royalties earned but uncollected are still ordinary income.
These assets are called Income in Respect of a Decedent (IRD). The technical definition in Section 691(a)(1) covers items of gross income to which the decedent had a right at death but which were not properly includible on a return for the period ending with that death.
Here is where the double-tax problem appears. If the estate is large enough to be subject to federal estate tax, the IRD asset is included at its full pretax value in the gross estate. That value is then subject to estate tax at rates up to 40%. When the beneficiary later receives the IRD as income, the same dollars are taxed again at ordinary income tax rates that can exceed 37% federal plus state. Without relief, the same dollar can be taxed at a combined effective rate well above 60%.
Section 691(c) is the relief. It gives the IRD recipient an income tax deduction equal to the portion of the federal estate tax attributable to the IRD that is included in the estate.
What Counts as Income in Respect of a Decedent
The category is broader than most people assume. Common examples include the following.
Traditional IRAs, SEP IRAs, SIMPLE IRAs, and 401(k) accounts. The decedent never paid income tax on the contributions or growth. Every distribution to a beneficiary is taxable as ordinary income. This is the most common form of IRD that families encounter.
Annuities. Deferred annuity contracts, the remaining payments under fixed-period annuities, and the survivor portion of joint-and-survivor annuities all contain ordinary income that was deferred during the owner's life. Section 691(d) provides specific rules for surviving annuitants.
Accrued compensation. Wages, commissions, bonuses, vacation pay, deferred compensation, and any final paychecks owed at death are IRD when paid to the estate or to a named beneficiary.
Installment sale notes. If the decedent sold a business or a piece of property and elected installment treatment, the unrecognized gain that flows through to the heirs as future payments is IRD. The face value over basis is the IRD amount.
Series EE and Series I savings bonds with accrued but unreported interest. Most owners elect to defer interest reporting until redemption. The accrued interest at death is IRD when the bonds are cashed.
Accounts receivable of a cash-basis business. A sole proprietor who used cash accounting may die holding substantial receivables that were never reported as income. Collection by the estate or successor is IRD.
Crop share rentals, royalties, and partnership distributive shares accrued but unpaid at death.
What is not IRD: capital gains on appreciated stock, real estate, collectibles, and the like. Those receive a stepped-up basis and avoid double taxation by a different mechanism. Roth IRAs are also not IRD because the contributions were made with after-tax dollars and qualified distributions are tax-free.
When the Deduction Is Actually Available
The Section 691(c) deduction is only useful if the decedent's estate was actually subject to federal estate tax. After the One Big Beautiful Bill Act, the basic exclusion amount is $15 million per individual and $30 million for a married couple beginning in 2026, with no sunset. The deduction is computed only against federal estate tax actually paid. State estate or inheritance taxes do not count for Section 691(c) purposes.
Three observations follow.
First, for most middle-class and even upper-middle-class estates, no federal estate tax is paid, so there is no Section 691(c) deduction to claim. The good news is there is also no double tax to relieve.
Second, the deduction also disappears to the extent IRD passes to a surviving spouse and qualifies for the unlimited marital deduction, or to the extent it goes to a qualifying charity. Those transfers reduce the taxable estate to zero on the IRD piece, so no estate tax is attributable, and no Section 691(c) deduction is generated.
Third, beneficiaries of estates in the $15 million to $30 million range and above should treat the Section 691(c) deduction as one of the highest-value items on their personal tax return. It can be worth six figures.
How to Calculate the Deduction
The mechanics are set by Section 691(c)(2) and Treasury Regulation Section 1.691(c)-1. The cleanest method, often called the "with-and-without" method, runs the estate tax calculation twice.
Step 1. Compute the federal estate tax on the actual taxable estate including the IRD item.
Step 2. Recompute the federal estate tax on a hypothetical taxable estate that excludes the IRD item but otherwise mirrors the actual estate.
Step 3. The difference between the two estate tax figures is the total estate tax attributable to IRD. That total flows pro rata to each IRD recipient based on their share.
A simplified example. Suppose Maria dies in 2026 with a $20 million gross estate, of which $3 million is a traditional IRA. Assume her exclusion is $15 million and her estate has no other significant deductions. Estate tax on a $5 million taxable estate at 40% is roughly $2 million. Without the IRA, the taxable estate would be $2 million and the estate tax roughly $800,000. The estate tax attributable to the IRA is $2,000,000 minus $800,000, which equals $1,200,000.
If Maria's three children each inherit one-third of the IRA, each receives the right to claim a $400,000 income tax deduction in total over time. The deduction is claimed in proportion to the IRD actually received in each tax year. If a child takes a $100,000 distribution in year one, the deduction for that year equals ($100,000 / $1,000,000) × $400,000, or $40,000. The remaining $360,000 of deduction stays available for future distributions.
At a 37% marginal federal income tax rate, that $400,000 lifetime deduction saves each child roughly $148,000 in federal income tax. Across three siblings, that is nearly $445,000 of tax savings the family would lose entirely if no one knew the deduction existed.
How and Where to Claim It
For an individual beneficiary, the Section 691(c) deduction is claimed on Schedule A of Form 1040 as an "other itemized deduction." It is reported on the line designated for amounts not subject to the 2% AGI floor.
This is the critical point. After the Tax Cuts and Jobs Act, most miscellaneous itemized deductions subject to the 2% floor were suspended through 2025 and remain suspended under subsequent legislation for ordinary employee business expenses and the like. The Section 691(c) deduction sits in a separate category. It is preserved because it is a deduction for an estate tax already paid on the same dollars being taxed again, not a personal expense.
A few specific filing notes.
- The deduction is claimed only in the year the IRD is received. If the IRA is paid out over a ten-year window under SECURE Act rules, the deduction is spread across those years in proportion to the amount distributed.
- The beneficiary must itemize to claim it. A beneficiary taking the standard deduction loses the benefit for that year. For someone receiving a large IRD distribution, itemizing usually wins anyway because the deduction itself is so large.
- For estates and trusts, the deduction is taken on Form 1041 and follows the IRD up the chain through Schedule K-1 to the ultimate beneficiary if the income is distributed.
- The deduction is allowed for alternative minimum tax purposes. It is one of the few itemized deductions that survives the AMT calculation, which is part of why it is so valuable.
Common Mistakes That Cost Families Six Figures
The same set of errors shows up year after year.
Missing the deduction entirely. A surprising number of CPAs and software packages do not flag the deduction automatically. The Form 706 estate tax return is filed by the estate's executor, often years before the beneficiary takes a large distribution. By the time the beneficiary needs the information, the executor is gone, the records are scattered, and no one remembers the schedule. The result is that the deduction is silently forgotten.
Not asking the executor for the IRD schedule. Beneficiaries should request, in writing, a copy of the estate tax return and a calculation of the Section 691(c) deduction allocated to them. The executor is the only person with the full estate tax picture. If you are an executor reading this, build the calculation as part of your closing package and hand it to each beneficiary along with their distribution.
Confusing federal and state estate taxes. Only federal estate tax counts. State estate or inheritance tax paid by a Massachusetts, Oregon, or Washington estate, for example, does not generate a Section 691(c) deduction even though it creates the same double-tax pattern.
Claiming the entire deduction in year one. The deduction must be apportioned to each year's IRD receipts. Front-loading the full deduction in the first year of distribution is a common preparer error.
Forgetting Roth conversions inside an inherited account. Inherited Roth IRAs are not IRD because no income tax is owed on qualified distributions. Do not claim a Section 691(c) deduction against Roth distributions.
Letting the deduction lapse on a small distribution year. The deduction is a use-it-or-lose-it for each year of distribution. Taking only a $10,000 distribution to "minimize taxes" can waste the proportional deduction available that year if other income would have made a larger distribution worthwhile.
A Closer Look at Inherited IRAs and the Ten-Year Rule
The SECURE Act and SECURE 2.0 changed inherited IRA distribution rules dramatically. Most non-spouse beneficiaries who inherit on or after January 1, 2020 must distribute the entire account within ten years. This compresses the timing of IRD receipt and, with it, the Section 691(c) deduction.
If the inherited IRA generated a $400,000 lifetime deduction and the beneficiary must empty the account within ten years, the deduction will be exhausted within that window. A common planning move is to align distributions with lower-income years to maximize the marginal benefit. A child still in school or on parental leave who can take a larger distribution at a low marginal rate captures both the lower bracket and the proportional deduction at the same time.
Eligible designated beneficiaries, such as surviving spouses, minor children of the decedent until majority, disabled or chronically ill beneficiaries, and beneficiaries not more than ten years younger than the decedent, can still stretch distributions over their life expectancy. The Section 691(c) deduction stretches with them.
Practical Workflow for Beneficiaries
When you learn you are inheriting an asset that may be IRD, work through this checklist within the first ninety days.
- Identify which assets are IRD. Get a copy of the death certificate, the will or trust, and the schedule of assets. Flag every traditional IRA, 401(k), annuity, deferred compensation arrangement, installment note, and accrued compensation item.
- Find out whether Form 706 was filed. Estate tax returns are required only for estates above the exclusion. Ask the executor in writing for a copy of the filed return and any amendments.
- If estate tax was paid, request the Section 691(c) calculation. Ask for the with-and-without computation and the allocation among beneficiaries. Keep this documentation; you will need it every year you receive a distribution.
- Plan distribution timing. Coordinate with your tax advisor to take distributions in years when your marginal rate is lower or when you have other deductions that would otherwise be wasted.
- Track receipts and deductions year by year. Maintain a running spreadsheet showing total IRD received cumulatively, total deduction claimed cumulatively, and remaining deduction available. Your preparer will thank you, and you will not lose a deduction to bad records.
Why Solid Bookkeeping Matters Here
The Section 691(c) deduction is a multi-year drama. The estate tax calculation happens once. The income tax deduction trickles out for as long as the IRD is being received, which can be decades for an annuity or the full ten-year window for an inherited IRA. The only way to claim the deduction accurately is to keep clear, durable records of three things: the total deduction allocated to you, the IRD you have received each year, and the deduction claimed each year.
People lose tax benefits not because the rules are too complicated but because the paper trail goes cold. A simple ledger that records every distribution, the source asset, and the running balance of the available Section 691(c) deduction will pay for itself many times over. The same is true for executors managing IRD distributions on behalf of trusts, family partnerships, or business entities.
Keep Your Inheritance Paperwork in Order from Day One
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