International Aspects of IRD

Tax advisers have long been familiar with Sec. 691 in the domestic context (i.e., when a decedent and beneficiary are both U.S. citizens or residents). However, rapidly increasing mobility has resulted in many situations in which either the decedent or the beneficiary (but not both) is not a U.S. citizen or resident.

The first situation is when a decedent has at all times been a U.S. nonresident alien, but his beneficiary is a U.S. citizen or resident. At the time of his death, the decedent had a right to receive deferred compensation (which was not a pension) for services performed entirely outside the U.S. The right comes into the hands of the beneficiary who collects the money. The question becomes, how will the money that the beneficiary receives be characterized. Under Sec. 691(a)(3), the money is treated as if it had been acquired by the beneficiary: 

[I]n the transaction in which the right to receive the income was originally derived [in this case, salary income from foreign sources because the services were performed entirely outside the U.S.] and the amount includible in gross income [of the beneficiary] shall be considered in the hands [of the beneficiary] to have the character which it would have had in the hands of the decedent if the decedent had lived and received such amount. (Emphasis added.)

Because, under Sec. 872(a)(2), foreign-source income is not taxable to a nonresident alien, it appears that the amount does not constitute income in respect of a decedent (IRD). The Sec. 691 regulations do not address the issue raised by Sec. 872(a)(2); conceivably, in other situations, the character could be limited to the nature of the income, regardless of the recipient's identity (i.e., the amount collected was merely foreign-source income, which, if collected by a U.S. person, would generally be taxable). However, the words "if the decedent had lived and received such amount" are totally unambiguous; it is clear that the right to the decedent's salary is not IRD. Moreover, the basis of the right in the beneficiary's hands is its fair market value (FMV) at the date of the decedent's death, as Sec. 1014(c) does not apply to property that is not IRD. Hence, such FMV may be less than the face amount of the rights, if the amounts are payable over time without interest.

The second situation occurs when a U.S. citizen or resident dies owning an installment obligation receivable that arose from the casual sale of a corporation's nonmarketable stock. The receivable comes into the hands of the beneficiary who is a U.S. nonresident alien. The beneficiary then collects the principal amount of the obligation. Once again, neither the Code nor the regulations address the beneficiary's nonresident alien status. Applying the conclusions reached in the first situation results in the conclusion that the beneficiary must report the installment gain attributable to his collection. A reporting (if not substantive) difficulty arises because the stock sale was neither "effectively connected income" (i.e., neither the decedent nor the beneficiary engaged in any trade or business taxable under Sec. 871(b)), nor "fixed or determinable annual or periodical income" (i.e., taxable under Sec. 871(a)). Note: apart from Sec. 691(a), gain from a casual sale of corporate stock not issued by a U.S. real property holding company would generally not be taxable to a nonresident alien, even if the gain were from U.S. sources. Probably the beneficiary's reporting of the gain under Schedule D of Form 1040, which supports Line 14 of Form 1040NR, U.S. Nonresident Alien Income Tax Return (even though the gain is not effectively-connected in-come), is the best approach. Although Sec. 691(c) allows a U.S. beneficiary a deduction for the U.S. estate tax attributable to IRD, the availability of such a deduction to a nonresident alien is uncertain, by reason of Sec. 873(a) (which allows a nonresident alien to take deductions only to the extent that they are connected with income effectively connected with the conduct of a trade or business within the U.S.), and the absence of a mention of Sec. 691(c) in Sec. 873(b), which sets forth three exceptions to the general rule under Sec. 873(a).

Numerous related aspects of the problem (such as foreign systems of devolution of property on death or the possible application of income tax treaties) complicate the situation further. In summary, advisers should make sure whether the collection of funds due a decedent represents income properly reportable under Sec. 691.

From Paul Farber, CPA, Richard A. Eisner & Company, LLP, New York, NY