The Final Return and IRD

The decedent’s final return

• The final year ends at death. A cash-basis decedent’s return includes what was actually or constructively received through the day of death; an accrual-basis decedent’s includes what had accrued, but not items that accrue solely because of death (§§451(b), 461(b)). Expenses are deductible only if paid before death, except medical expenses paid within one year after death (§213(c) election; the executor files a statement waiving the 706 deduction).
• Self-employment tax stops at death. Schedule C income through the date of death is SE income on the final 1040; the same business run by the estate afterward is reported on the estate’s Schedule C with no SE tax (§1401 applies to individuals only). A farm the same; the estate reports crop-share rents on Schedule E, not Form 4835.
• Carryovers die. Net operating loss, capital loss and charitable contribution carryovers unused on the final return are gone; the estate does not inherit them (Rev. Rul. 74-175). §691(b) carries only §162 and §212 deductions, interest, taxes, depletion and the foreign tax credit. added 2026 Suspended passive losses are the exception: deductible on the final return to the extent they exceed the step-up in basis (§469(g)(2)). Planning for a dying client with a large capital-loss carryover: realize gains before death.
• If annuity payments stop at death, the unrecovered investment in the contract is an itemized deduction on the final return, not a miscellaneous one (§72(b)(3), §67(b)(10)).
• Joint return with the surviving spouse (§6013(a)(2)–(3)): the executor must consent, or the spouse files it if no executor has been appointed by the due date; the spouse must not remarry before year end; the decedent’s income runs through the date of death, the survivor’s for the full year.
• Accrued U.S. savings bond interest: the executor may elect to report all of it on the final return (§454), which uses up the decedent’s lower bracket and spares the heirs IRD; otherwise it is IRD to whoever cashes the bonds.

Splitting the 1099s

• Payers issue one 1099 in the decedent’s name and SSN for the whole year; that is normal and is not amended. Report the full 1099 amount on the final Schedule B, subtotal, then subtract the post-death portion on the next line labeled “Form 1041” with the estate’s name and EIN (the nominee procedure from the 1041 instructions). The estate picks up the subtracted amount.
• Dividends: a dividend declared before death with a record date before death and paid after is IRD to the estate for a cash-basis decedent (constructive receipt turns on payment). Mutual fund capital gain distributions follow the same date rule.
• Brokerage consolidated 1099s arrive February 15 and are often corrected; work from the December statements and the date-of-death valuation.

Income in respect of a decedent

• Defined (Reg. §1.691(a)-1(b)): amounts the decedent was entitled to as gross income but which were not properly includible in the final return under his method of accounting. The list: the final paycheck; accrued vacation and sick pay (Rev. Rul. 55-229); wages for the last illness (Rev. Rul. 59-64); deferred compensation; bonuses; renewal commissions; IRA, 401(k) and annuity balances; U.S. savings bond interest; installment-sale payments; a cash-basis professional’s receivables; a deceased partner’s share of partnership income through death (Reg. §1.742-1) and a deceased S shareholder’s per-share per-day share (§1377(a)); dividends declared and unpaid; rent and interest accrued and unpaid.
• Who reports it (§691(a)(1)): the estate, if the estate collects it; the heir, if the right passed directly by beneficiary designation or operation of law, or if the estate distributed the right before collecting. The transfer of the right itself is not income unless sold to a third party. Character is preserved (§691(a)(3)): wages are ordinary, a capital-gain installment is capital gain.
• No step-up (§1014(c)). For a partnership interest the estate’s §1014 basis is reduced by the IRD component (Reg. §1.742-1); ask the partnership about a §754 election.
• Inventory or a business asset in the decedent’s hands may be a capital asset to the estate, because character is tested in the estate’s hands (Maley, 17 T.C. 260) — subject to the IRS arguing IRD for work the decedent did (Linde).
• IRD goes on Form 1041 line 8 (other income) or the schedule where it belongs; on the K-1 it is box 5 (IRA and annuity income, compensation) or the business and rental boxes.

Deductions in respect of a decedent

• §691(b): business expenses, §212 expenses, interest, taxes and depletion that the decedent owed but had not paid are deductible by the estate or heir who pays them — and on the Form 706 as debts of the decedent. No §642(g) election or waiver is needed. The decedent’s state income tax on the final return paid by the estate is the common one; accrued property tax at death is another (course Example 3.5).
• The foreign tax credit attributable to IRD passes the same way (§691(b)(2)). Nothing else — no NOL, no capital loss carryover, no charitable carryover, no general business credit.

The §691(c) deduction

• The recipient of IRD deducts the federal estate tax attributable to it: the estate tax with the IRD included less the estate tax without it, apportioned among the IRD items. An itemized deduction not subject to any floor (§67(b)(8)) and not a miscellaneous itemized deduction; the fiduciary deducts it on line 19 of the 1041 and it reduces DNI only indirectly (it is added back under §643(a)). On a K-1 it is box 10. For a joint-and-survivor annuity the deduction is spread over the survivor’s life expectancy (§691(d)).
• At a $15 million exemption almost no Tax Shop estate pays estate tax, so the deduction almost never arises; when a client inherits from a taxable estate elsewhere, ask for the 706.

At the desk: the first meeting after a death

• Death certificate; letters testamentary or the trust and the acceptance of trusteeship; the will; the decedent’s last three returns (to see which carryovers are dying and whether estimates were paid).
• Form 56 at appointment; Form 8822 for the decedent; SS-4 for the estate (and for the trust if it ran on the SSN); the executor’s choice of fiscal year; whether a 706 is required or a portability return is wanted.
• Every account statement at the date of death: for basis (step-up), for the 1099 split, and for the IRD list.
• Form 4810 (prompt assessment, 18 months, filed returns only) and Form 5495 (discharge from personal liability) once the returns are in — The Paper Trail.

Private reference, not client advice. Notes taken from two continuing-education courses: Form 1041: A Practical Guide (Hadges & Zollars, Thomson Reuters Checkpoint Learning, 10 hours, written on 2019 law) and Taxation of Trusts, Estates, and Decedents (DeScherer & Rodda, CeriFi, 2025 printing on 2024 law). Figures and rules brought current to 2026 in October 2026 (P.L. 119-21, Rev. Proc. 2025-32, T.D. 9918). Items tagged check are to be confirmed against primary sources before they are relied on.