SBJPA change to IRD items for decedents holding S stock.

• Author: Sattler, Jay M.
• Position: Small Business Job Protection Act, income in respect of decedent

The Small Business Job Protection Act of 1996 (SBJPA) included several significant legislative changes to the tax provisions affecting S corporations. Included in these changes is the addition f Sec. 1367(b)(4)(A) and (B). This section provides that any person acquiring stock in an S corporation by reason of the death of a decedent or by bequest, devise or inheritance shall apply Sec. 691 to any item of income of the S corporation in the same manner as if the decedent had held directly his pro rata share of such item. In other words, such person must treat as income in respect of a decedent (IRD) the pro rata share of any item of income of the corporation that would have been IRD if the income had been acquired directly from the decedent. What this section means and what effect this modification will have can best be analyzed by first understanding IRD, the IRD tax provisions as they apply to partnerships, and how the new legislation applies to S stock.

What Is IRD?

IRD is, generally, income earned before the decedent died but received after his death. For a cash-basis taxpayer, this means the taxpayer was entitled to the income during his life but did not live to constructively or actually receive it. For example, IRD may include unrealized receivables, installment sales entered into prior to death payable after death, deferred compensation received after death, or the decedent's final paycheck received after his death. Sec. 691 and the regulations thereunder provide that (1) the decedent's estate or other successor to the decedent must include IRD in income when received; (2) the character of the IRD is determined as if the decedent had actually received the IRD; and (3) under Sec. 691 (c), the successor to the decedent is entitled to an income tax deduction for the estate tax attributable to the IRD in the same year the IRD is includible in income by the successor.

IRD and the Partnership Provisions

On an individual basis, the estate or other successor generally takes a basis in the decedent's property equal to the asset's fair market value (FMV) at the time of death. Normally, this process eliminates from income taxation the unrealized appreciation in an asset's value. However, this step-up in basis applies only to the unrealized appreciation of assets owned by the decedent at death. It does not apply to income earned or realized but not yet reported by the decedent at the time of death. For example, assume a cash-basis individual...