Have you received money that was earned by a loved one who passed away? This income, known as income in respect of a decedent (IRD), is an unusual tax matter that can have implications for the one who receives it as well as anyone who may be affected by the person's estate.

To help you understand how to handle the tax consequences of this money, here's a brief rundown of how this income affects three tax filings.

The Decedent's Final Return

Income in respect of a decedent is actually different from the income that is reported on the person's last tax return. For IRS purposes, the final tax return of an individual who passes away includes all money received or effectively received as of the date of their passing. This would include a paycheck received the day before, but it would generally not include money earned toward the next paycheck.

The Receiver's Tax Return

Income that was earned by your loved one before their death is generally reported on the Form 1040 of whoever is legally entitled to receive that money on their behalf. Such earned — but not yet paid — money often includes paychecks, interest on savings, dividends from investments, and business profits. 

The receiver includes these items as income on their own tax returns. They can offset some of this new income, though, through deductions. They may take certain deductions for expenses that could not be included on the decedent's final tax return (such as medical expenses or taxes paid). A married couple filing jointly can also take the full annual standard or itemized deduction when one passes away. 

The Estate Tax Return

The third part of the IRD tax puzzle is the estate tax return. All estates in the United States are subject to estate taxes, but there is a significant exemption before the estate reaches a taxable threshold. In 2019, the first $11.4 million is exempt from estate tax. 

Income in respect of a decedent is included in the estate tax filing even though it was also included in the receiver's taxable income. This is a sort of double taxation, but the estate is allowed to also take the same deductions for expenses the receiver did as well. 

If you have received or expect to receive income that was earned by your loved one, consult with a tax preparer or accountant about reporting it. This area can be complicated, and you don't want to make errors or omissions that could result either in too much tax owed or a notice from the IRS during this difficult time.