Estate not taxed on transfer

Estate not taxed on transfer of decedent’s pension to charitable beneficiary PLR 200845029

IRS has privately ruled that an estate will not be taxed on a distribution of the decedent’s pension benefits to a charitable beneficiary of the estate.

Facts. An individual, whom we’ll call, Smith, died owning an interest in a defined benefit pension plan (the Plan Interest) of which his estate (Estate) was the beneficiary. His will (Will) named Charity as a residuary beneficiary. The executor of Estate proposes to assign the benefit of the Plan Interest to Charity in partial satisfaction of Charity’s share of the residue. The Will gave the executor the power to distribute property in kind and state law further allows distributions in kind without any requirement that they be made on a pro-rata basis.

Background. Income earned by an individual before death that isn’t included on his final return because of his accounting method (usually income that has been earned or accrued but hasn’t been actually or constructively received by a cash method taxpayer) is known as income in respect of a decedent or IRD. A decedent’s IRD must be reported, for the tax year when received, by:

  • the decedent’s estate, if it acquired the right to receive the item of income from the decedent;
  • the person who, by reason of the decedent’s death, acquires the right to the income whenever this right isn’t acquired by the decedent’s estate from the decedent; or
  • the person who acquires the right from the decedent by bequest, devise or inheritance, if the amount is received after distribution by the decedent’s estate of the right to the income. (Code Sec. 691(a)(1))

A transfer of a right to receive IRD is taxable to the transferor in the year of the transfer in an amount equal to the fair market value of the right or the amount received for it, whichever is greater. For this purpose, a transfer includes a sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the person’s right to receive the amount by reason of the decedent’s death or by bequest, devise, or inheritance from the decedent. (Code Sec. 691(a)(2))

If the estate of a decedent or any person transmits the right to IRD to another who would be required by Code Sec. 691(a)(1) to include such income when received in his gross income, only the transferee will include such income when received in his gross income. In this situation, a transfer within the meaning of Code Sec. 691(a)(2) has not occurred. (Reg. § 1.691(a)-4(b))

Under Reg. § 1.691(a)-4(b), if a right to IRD is transferred by an estate to a specific or residuary legatee, only the specific or residuary legatee must include such income in gross income when received.

Favorable ruling. The ruling concluded that the assignment of the Plan Interest to Charity in partial satisfaction of its share of the residue of Estate won’t be a transfer within the meaning of Code Sec. 691(a)(2). Thus, only Charity will include the amounts of IRD in the Plan Interest in its gross income when the distribution or distributions from the Plan Interest are received by Charity.

Observation: Thus, while the pension benefits are included in Charity’s income, as a practical matter, since Charity is a tax-exempt entity, this means the pension benefits will escape tax.