So, not so hypothetical situation here. I have changed John's name to protect his anonymity.
John has a note to a corporation. Said note has a principle balance of $1.5M and accrued interest of $2.5M when he died in July of 2021.
A note for $2.5M is includable in his estate, because that is the FMV of the note. This note is not discounted in any way, because in January of 2022 it was paid in full.
John's estate didn't have a tax liability for the $1M of interest income, because as a cash-basis taxpayer, no income was recognized until 2022 when the interest was received.
I am not liking this result since the loan's FMV is includable, but the inherent tax liability seems not to be includible as a deduction due to timing.
Is there a special provision here? For instance, legal claims that existed at the time of death, but were not paid until later.
I'm getting a bit muddled here, because this liability will show up on a future year tax return.