Hannah died on 14 May. Her will appoints her son Peter as executor and sole beneficiary. Her assets are a traditional Individual Retirement Account worth 300,000 dollars, payable to her estate, on which no income tax has ever been paid, and a share portfolio worth 700,000 dollars that she bought for 200,000 dollars. The estate is large enough that federal estate tax is payable, and the estate tax attributable to the retirement account is 96,000 dollars. Peter asks how the account will be taxed when the estate collects it, and whether he has any choice about the tax year the estate reports on. Which answer is correct?
- AThe account takes a new basis equal to its value on the date of death in the same way as the shares, so the estate collects the 300,000 dollars free of income tax, and the estate must report on a calendar year ending on 31 December
- BThe account is ordinary income to the estate when collected, no relief is available for the federal estate tax the account bore, and the estate must adopt a calendar year because only a living individual may choose a fiscal year
- CThe account is taxed to the estate as long-term capital gain because Hannah had held it for many years, and the estate may adopt a fiscal year ending on the last day of any month within twelve months of the date of death
- DThe account is income in respect of a decedent, taxed as ordinary income with no step-up in basis, the recipient may deduct the 96,000 dollars of federal estate tax attributable to it, and the estate may adopt a fiscal year ending on the last day of any month within twelve months of the death Correct
Why A is wrong: This applies the basis rule for the shares to the retirement account, but an item of income the decedent had earned and not yet been taxed on is carved out of the step-up, so the whole 300,000 dollars remains taxable when collected.
Why B is wrong: The income characterisation is right, but the answer denies the deduction for estate tax attributable to the item and wrongly bars an estate from choosing a fiscal year, which an estate may do in its first return.
Why C is wrong: The fiscal year half is correct, which makes the option attractive, but a distribution from a traditional retirement account is ordinary income in the recipient's hands and the holding period of the account does not convert it into capital gain.
Why D is correct: Untaxed income the decedent had a right to receive keeps its ordinary character, is denied a basis adjustment, carries a deduction for the estate tax it generated, and an estate elects its tax year on its first income tax return.