[Updated 2/28/2024]
The Pennsylvania personal income tax treats “income in respect of a decedent” (often referred to as “IRD”) in a way that is completely different from the federal income tax treatment of IRD, and practitioners dealing with estates of Pennsylvania decedents should be aware of the difference.
“Income in respect of a decedent” is defined by I.R.C. section 691, and refers to money or property received after the death of a decedent which was not properly included in the decedent’s income during his or her lifetime, but would have been income to the decedent if received during the decedent’s lifetime. Typical examples of IRD include:
- Wages, salaries, and other compensation earned during lifetime but not paid until after death.
- Interest accrued during lifetime but not received until after death.
- Dividends payable to the shareholders of record as of a date before death but not actually paid until after death.
- Individual retirement accounts and other retirement plan benefits paid after death.
- Annuities that continue to be paid after death.
- Payments on notes or contracts that include capital gains being realized on an installment method.
Federal law is clear that items of IRD received by an estate or beneficiary are included in gross income and have the same character for federal income tax purposes as the items would have had in the hands of the decedent. But that is not the rule for Pennsylvania income tax purposes.
The Pennsylvania personal income tax applies to eight different classes of income, and income is taxable only if it falls within one of those eight classes. (By comparison, federal law taxes “all income from whatever source derived.”) It has always been clear from the definitions of those classes of income that at least some IRD was not included in those definitions, and so not taxed. For example, taxable “compensation” is defined as amounts received by an “employee,” and an estate receiving wages earned by a decedent is not an “employee.”
Currently, the Department of Revenue seems to take the position (see qualifications below) that nothing that is IRD is subject to income tax:
- The instructions to Form PA-40 for 2023 (but not the PA-41, for some reason) includes a list of income not taxable, and included in the list is “Inheritances, death benefits, and income in respect of a decedent (IRD) as defined for federal income tax purposes.” However, there is a parenthetical that “(NOTE: IRD may be subject to the PA PIT in a class of income other than compensation)”. (See comment below.)
- In a section on employer-provided retirement benefits, the 2023 instructions to Form PA-40 also state that “Payments paid to the estate or designated beneficiary upon an
employee’s death are not PA-taxable income on the employee’s final PA-40 or on the decedent’s estate or trust PA-41, PA Fiduciary Income Tax Return or on the beneficiary’s PA-40.”
“The federal rules for income in respect of decedent are not controlling. Pennsylvania has no rule similar to that for federal income tax purposes that governs income in respect of a decedent. Therefore, income in respect of a decedent is not includible on the tax return of the decedent or the estate tax return of the decedent. Assuming the decedent used the cash basis of accounting before his death, his or her final return would include only income actually or constructively received through the date of death.
“Any item of income or deduction that would have been reportable on the last return if the taxpayer had personally used the accrual method of accounting that is not reportable or deductible thereon using the cash basis method is taxable to, or deductible by, neither the decedent nor his estate, heirs or beneficiaries. For example, taxpayer earned a bonus as of Dec. 31 payable on April 15, but taxpayer died on March 15. This income would not be taxable anywhere.”
- The 2023 instructions to Form PA-41 states that, if compensation reported on the final Form W-2 is received after death, “a letter of explanation must accompany the individual’s final return advising that the income was income in respect of a decedent and, therefore, is not subject to Pennsylvania personal income tax.” The same instructions also confirm that an estate is entitled to a credit for “Pennsylvania income tax withheld on income in respect of a decedent (not taxable for estate or trust income tax purposes, but includable in the value of an estate for inheritance tax purposes)….”
Income in respect of a decedent should therefore be reported on the Pennsylvania inheritance tax return if otherwise included in a taxable transfer, and on a federal fiduciary income tax return (Form 1041), but should not be reported on a Pennsylvania fiduciary income tax return (Form PA-41) or an individual income tax return (Form PA-40).
In a 12/10/2018 update, it was suggested that the Pa. Department of Revenue may be changing its position on the taxation of IRD, because the instructions to Form PA-40 for 2017 added the note quoted above: “(NOTE: IRD may be subject to the PA PIT in a class of income other than compensation).” The instructions to Form PA-40 therefore seem to conflict with the Pennsylvania Personal Income Tax Guide. The 2018 update suggested that this might represent a beginning of a change in policy, but it now appears to be nothing but an example of inconsistent revisions to forms.
However, the tax treatment of annuities may be less ambiguous. The “classes of income” subject to Pa. income tax include “any amount paid under contract of life insurance or endowment or annuity contract which is includable in gross income for Federal income tax purposes.” 72 P.S. 7303(a)(6). The literal application of that language would lead to the conclusion that annuity income is taxable for Pennsylvania purposes regardless of whether the federal taxation is derived from I.R.C. section 72 (annuities) or section 691 (income in respect of decedents).