Estate tax on tax-deferred account

Yes. Well, actually the entire $2.5 million is subject to tax, with a credit for the tax that would be owed on $2 million. The difference is that the tax calculated this way is in a higher bracket than just taxing $500,000.

Income tax and estate tax are separate and have little to do with each other. So the answer to that is no. By the way, income tax on that amount may or may not be deferred after death, depending on who the beneficiary and how it is handled.

Estate tax is due on the full amount, and income tax is due on the full amount that is subject to income tax unless a further deferral applies. There may be an estate tax deduction for income tax paid, or an income tax deduction for estate tax paid, but I don't know that off the top of my head. Stu

Yes, indeedy. BTW, it is not an "estate tax credit", but rather an estate tax exception.

No

The second one. BTW, the heir may have an income tax deduction for the estate tax paid on a portion of the IRA account. In addition, there is NO stepup of basis in the tax deferred account so income tax is due on the entire amount, when distributed.

The issue is addressed by the "income in respect of a decedent" (IRD) rules as described in great details at:

If the scenario you describe has not yet occurred, I'd first ask if there's a spouse, in which case the use of a properly set up trust can allow for the unlimited marital transfer, and preserve the $2M for the other beneficiaries. Alternately, the use of Roth conversions can reduce the estate, and give the beneficiaries a 'denser' inheritance. (i.e. one no taxable at all). Last, one can gift $12K/yr to any number of recipients during their lifetime, another way to get money out of one's taxable estate. Joe

Thanks for your reply. Given that the full value of the tax-deferred account would be subject to the estate tax and income tax, it would seem prudent for the account holder to withdraw the full account while alive, pay the income tax, and leave a smaller estate subject to estate tax (if any). Of course, the account holder would lose the value of tax-deferred growth of the account, but the double whammy of income and estate tax on the whole amount must be more onerous.

If an unliquidated asset (i.e. a debt) would otherwise be included in the decedent's estate for estate tax purposes but is also considered income in respect of a decedent, that amount is not taxed twice. It is subject to income tax (generally in a lower bracket than estate tax) and is excluded from the estate for estate tax purposes. Stu

Stu - I humbly ask if you read the link, which I provided as The CPA Journal appeared to be a trusted source. I also found corroborating reference to this in Ed Slott's latest book, "Parlay your IRA into a Family Fortune." I recalled this rule (IRD) from having read the book when it was first published, and googled to find the reference I posted. The OP has replied, and is on a path to taking the funds out to reduce the estate to avoid the double taxation, which does not exist. That would be a shame. JOE

That leads to an interesting issue: What is the Fair Market Value of an IRA with $2.5 million in it? If they were freely transferrable, and I had the cash, I wouldn't pay $2 million for one, because taking the money out would cause me to have less than $2 million after taxes. Anybody who could afford to buy it for cash would probably be in a high tax bracket, which lowers its value (to around $1.5 million). On the other hand, the fact that money in it grows tax-free increases its value. The net answer is, I don't know, and there's probably some specific mention in the Code that says it's valued at face for estate tax purposes. Seth

I did read it, but I didn't see any particular relevance to this situation. I have to admit, though, that I did not read it as carefully as I might if I were getting paid for doing it.

If he takes funds out he pays income tax but presumably not estate tax, is that the point? But to the extent the estate pays income tax, there is a deduction for purposes of the estate tax (which is generally at a higher bracket than the income tax). So it should come out the same both ways. Stu

An interesting thought. Of course the IRA is valued as you said, at "face value" if populated with liquid securities. I think your suggestion may apply if (and only if) there were assets that had no liquidity at all, for example, a joint venture where it's not obvious that an outsider would easily wish to purchase the shares held within the IRA. This strikes me as similar other estate planning techniques in which shares of an (illiquid) family business are gifted at a discount, sometimes $12K at a time, sometimes into a trust, over time. In the end, the wealth transferred is greater than the required amount for disclosure purposes. Even a half share in a rental property would be the subject of this type of 'discounting'. JOE

I understand the CPA article now. One more question: are non-qualified stock options considered to be IRD?